Full text of Federal Reserve Oral History Interviews : Interview with Stephen H. Axilrod, Former Staff Director for Monetary and Financial Policy

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Federal Reserve Board Oral History Project
Interview with

Stephen H. Axilrod
Former Staff Director for Monetary and Financial Policy

Date: October 22, 2008
Location: New York, New York
Interviewers: David H. Small and Cynthia Rotruck Carter

Federal Reserve Board Oral History Project
In connection with the centennial anniversary of the Federal Reserve in 2013, the Board undertook an oral
history project to collect personal recollections of a range of former Governors and senior staff members,
including their background and education before working at the Board; important economic, monetary
policy, and regulatory developments during their careers; and impressions of the institution’s culture.
Following the interview, each participant was given the opportunity to edit and revise the transcript. In
some cases, the Board staff also removed confidential FOMC and Board material in accordance with
records retention and disposition schedules covering FOMC and Board records that were approved by the
National Archives and Records Administration.
Note that the views of the participants and interviewers are their own and are not in any way approved or
endorsed by the Board of Governors of the Federal Reserve System. Because the conversations are based
on personal recollections, they may include misstatements and errors.

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Contents
Educational Background................................................................................................................. 1
Early Years at the Board: The Division of International Finance and the Flow of Funds Section 5
The Banking Section, Writing Purposes and Functions and the Board’s Role in Bank
Regulation, and the Creation of the Bluebook................................................................................ 7
Monetary Policy and Economic Forecasts.................................................................................... 13
The Great Inflation........................................................................................................................ 16
Chairman Martin: Advisers and Political Pressure...................................................................... 19
The Burns Chairmanship and Inflation during the Burns/Miller Era ........................................... 21
Fed Chairman Volcker: Early Acquaintance ............................................................................... 30
1979 New Operating Procedures .................................................................................................. 32
Financial Fragility and Crises ....................................................................................................... 43

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MR. SMALL. Today is October 22, 2008. I’m David H. Small from the FOMC (Federal
Open Market Committee) Secretariat in the Board’s Division of Monetary Affairs. I am joined
by Cynthia Rotruck Carter from the Board’s Division of Bank Supervision and Regulation. We
are interviewing Stephen H. Axilrod, who was the Staff Director for Monetary and Financial
Policy at the Board for many years, culminating a career of 34 years at the Board from 1952 to
1986. 1 Let’s begin with your educational background.
Educational Background
MR. AXILROD. My education began at PS 99 in Kew Gardens, New York. With the
stock market crash of 1929, my father lost all his money by 1932, but he was never unemployed,
and he was proud of that. Early in the Great Depression, he quickly got a job with a securities
firm taking orders from their few surviving customers. In 1937, we all shoved off to Texas
where my father initially went to work as sales manager for a small manufacturing concern in
Dallas and later, with partners, established his own.
I spent my junior high and high school years in Highland Park Junior High and Highland
Park Senior High. My first year and a half at college was at Southern Methodist University
(SMU), which was across the street from us. We lived on Daniels Avenue. The year and a half
at SMU included a summer session. I made good grades at SMU, but I didn’t like to study. One
day my Shakespeare professor came to me in the hall and said, “Mr. Axilrod, go east to college.”
[Laughter]
Later, I went into the service. My overseas duty, of all places, was in Bermuda. I was in
the Seabees. After the war, on the way back to be discharged at the Naval Air Station in

1

Stephen H. Axilrod (2011) is the author of Inside the Fed: Monetary Policy and Its Management, Martin through
Greenspan to Bernanke, revised ed. (Cambridge, Mass.: MIT Press).

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Norman, Oklahoma, I stopped off at Harvard and took an admissions exam just to take it. Why
not? I joke with people by saying it was a spelling test. I don’t remember what else was
included. When I got home, I reenrolled at SMU. Then, a few days before I was supposed to
start at SMU, I got a letter from Harvard that said, “Come up here.” I spent two years at
Harvard from 1946 to 1948. I got all sorts of extra credit for service school, boot camp, and
things like that.
MR. SMALL. In what subject did you major?
MR. AXILROD. I majored in economics. Then I wanted to combine economics and
politics, so I applied to the London School of Economics for graduate work. I was accepted to
be a student of the famous British economist Lionel C. Robbins; he was my adviser. Also, I
would have taken courses from Harold J. Laski, a well-known British political theorist in those
days, but my father had a heart attack, so I decided to stay in the United States. I didn’t want to
go into his business, so instead I went to the University of Chicago. It had a planning program
that combined economics, physical planning, and sociology. That appealed to me. The program
was then headed by Rexford G. “Rex” Tugwell. He had served in Franklin Delano Roosevelt’s
Administration and was one of the chief contributors to FDR’s New Deal. After two years at the
University of Chicago, I received my master’s degree. Then, with my new wife, I went to Puerto
Rico for a year to work at its planning board.
After that experience, I said to myself, “I don’t know enough economics.” Planning
didn’t teach you substantive skills as much as I wanted. So I went back to Chicago and did a
year’s worth of economics to finish, because I had already taken some economics while in
planning. Then I took the three exams required to obtain a Ph.D. if you passed them at that level.
One of the exams was on planning, and the others were on money and banking and on economic

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theory. I had no problem, in part because I studied my wife’s undergraduate notes from a class
that she took from Milton Friedman. My graduate money and banking class was not so good; it
was taught then by an older professor named [Lloyd] Mints. I passed the money exam easily at
the Ph.D. level with my wife’s notes. I took the exam on theory after I went to work at the Fed.
They sent it to me. I studied actively over one weekend and passed that exam too. But I never
bothered with writing a dissertation, because the Board was such a nice place to work and I was
promoted every year. That seemed like a good thing to keep going.
MS. CARTER. Did you go to the Board directly?
MR. AXILROD. Yes—after I came back from Puerto Rico and then finished all the
work at the University of Chicago, except this last little thing on the theory prelim, I went job
hunting. It wasn’t easy at the University of Chicago to find people who knew people working at
places in the government where you would want to apply for a job.
Milton Friedman was becoming well known at that point. The best professor the
University of Chicago had in economics at the time, in my opinion, was an older man named
Frank H. Knight. He seemed old to me then, but I think he was 10 to 15 years younger than I am
now. He taught an interesting theory course and was absolutely brilliant. I took it in the
summer. The guy I liked best was Lloyd Metzler, who taught international trade. Unfortunately,
he got a brain tumor, and I had him toward the end of his career. He was young, and he knew
people in Washington.
I went to the New York Federal Reserve Bank and talked to someone whose name I can’t
remember right now. Then I went to the Board of Governors of the Federal Reserve System in
Washington, the Department of Agriculture, and the Department of Interior because of my

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planning background. Interior had a planning office that was interesting, but I thought the
election was going to go the wrong way for planning.
MR. SMALL. This was 1952?
MR. AXILROD. Yes, just before Dwight D. Eisenhower’s election. And it did go the
wrong way for planning. They threw this little office out.
Anyhow, the Board was the first place to offer me a job. And I said to myself that you
don’t look a gift horse in the mouth when you’re that young and newly married. We had been
married two years or so. So off I went to the Board, and I started in the Division of International
Finance, where I spent four or five years. The director of the International Division was Arthur
W. Marget. He was famous mainly because he wrote two volumes against John M. Keynes,
which was not the way to become famous in a positive way in the 1950s. [Laughter]
At Harvard, I had written my undergraduate thesis under Alvin H. Hansen, who was then
the most well-known American Keynesian. In the last half of my senior year, I was taking a
thesis course. Hansen had been my academic adviser for two years. He was the person who
supervised the course. About halfway through, I got a call from his secretary. She said,
“Professor Hansen would like to see the thesis or the draft.” I said, “Oh, I didn’t know he was
interested.” I trotted off and gave him the paper. He gave me a very good grade on what I had
written. I finished it, and it helped me get pretty good honors at graduation.
In any event, I had absorbed Keynesianism, but when you went to Chicago, you had to
absorb something else in economics to pass your prelim. One of the things I used to say in
speeches is that, for the honors exams at Harvard, the answer to the particular question was: If
there were economic troubles, you tried creating money by lowering interest rates, but there’s a
limit to how much you can lower the interest rates, because there’s a liquidity trap. At some

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level of low interest rates, no one wants more money, and you can’t lower interest rates anymore.
But, for the Ph.D. exam for money at the University of Chicago, it was obvious that was not a
satisfactory answer. You had to say that there’s no liquidity trap, because there’s a “Pigou
Effect,” which meant that more money represents more wealth, and that itself will affect
spending. People didn’t think about excess reserves so much in those days. Anyhow, that was
the answer you had to give then.
This training at both Harvard and the University of Chicago helped me to see different
sides of things. The real question is, which is right? It gets to be empirical. Nowadays, in
answering such questions, you get to say something about Alan Greenspan and the Japanese and
about the liquidity traps. Greenspan thought the United States could get into a liquidity trap, but
we didn’t in his tenure; however, the Japanese truly were in one in the 1990s and couldn’t get out
of it mainly because banks held on to excess reserves at near-zero overnight money market rates.
Early Years at the Board: The Division of International Finance and the Flow of Funds
Section
MR. SMALL. When you arrived at the Board in 1952, the accord between the Federal
Reserve and the Treasury had just been reached. What was your sense of the role of the Fed?
MR. AXILROD. I was in the international area for around four or five years. The
Division of International Finance had absolutely no importance at the Board then. I don’t
believe the director of the International Division was even on the staff of the FOMC. He might
have attended the meetings. The only person in the International Division who had close contact
with Chairman William McChesney “Bill” Martin was me. That was because I had a carpool
mate who played tennis with the Chairman and got me involved. [Laughter] After about a year,
I was playing tennis maybe three or four times a week with Bill Martin and the then Vice Chair,
J. Louis Robertson. Those games were highly pleasurable. After four years or so, I was in the
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Board members corridor wearing a suit and tie and Martin happened to walk out of his office as I
went by. He looked and looked again. This was the first time he saw me in mufti (ordinary
clothes) and didn’t quickly recognize me. He’d only seen me in tennis shorts.
MS. CARTER. Where were the tennis courts back then?
MR. AXILROD. In the middle of where the new Fed building is—new to me. There
was a huge parking lot, and in the middle of that parking lot were two tennis courts.
MS. CARTER. Presumably not where they are now.
MR. AXILROD. No, no. When the Martin building was built, those two courts
becameone, in back of the new building. But that new court turned out to be on public
parkland, so playing on that court got complicated. You couldn’t just reserve it for the Board
employees only.
Anyway, I saw the Board from a very different perspective in those first four or five
years. I didn’t really give any genuine thought to the Board’s principal role, which was
monetary policy. In the Division of International Finance, you were supposed to write articles
and get them published. My specialty was on the capital account and the U.S. balance of
payments. I got the first four articles I wrote published by the Review of Economics and
Statistics at Harvard.
MR. SMALL. We were still under the Bretton Woods system. The dollar was still fairly
stable then, and the real crisis over the dollar hadn’t hit yet.
MR. AXILROD. Well, I came in with the preconception that the Fed had botched things
in the 1930s. That was clear, coming from the University of Chicago. My wife had written her
master’s thesis on the 1937–38 recession caused by the Fed. We got married nonetheless, but we
had big arguments over her thesis draft, because I came at it from a different perspective. I

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thought the absence of an expansionary fiscal policy was mucking things up. I knew the Fed had
done wrong during the recession. Part of that was because of the legal requirements behind
currency that existed at the time. Those requirements were outdated and, in my mind, limited
any expansion. But I thought the basic problem was fiscal policy. The academic profession in
those days didn’t believe in budget deficits, so no one believed you could spend your way out.
That’s crazy.
Those were some of my priors as I came in, but I had no way of thinking about them in
the international division, so I made efforts to get out of there. In the end, I did get out by getting
a job in the Flow of Funds Section of the domestic research division. Again, I wasn’t really
involved in monetary policy or thinking about it. My job was to make something analytic out of
the flow of funds, which was a big compilation of data. The truth being told, it ended up not
being useful for anything in particular. But I made an analysis of savings flowing among sectors
and how they flowed to investment. It kind of worked, and I used it for something.
Anyhow, it got me better known. So when an opening came in the Banking Section, I
said, “I’d better go ahead and apply to this one.” So I got out of flow of funds and into banking.
The Banking Section, Writing Purposes and Functions and the Board’s Role in Bank
Regulation, and the Creation of the Bluebook
MR. SMALL. Was this around 1960?
MR. AXILROD. It might have been somewhere around 1958. I don’t know whether I
was going to FOMC meetings yet. I think somewhere in the early 1960s I started going. I got
into the Banking Section. I was maybe a grade 13 or 14. I had been promoted. I started at the
lowest professional grade, the GS-7. So if I got a promotion every year—7, 9, 11, 12, 13—
then I would have been a grade 14 in 1956, something like that. That might have been four or
five years.
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At one point, Ralph A. Young, who was then head of the Division of International
Finance, came and asked me to help him write Purposes and Functions. 2 I learned how the
Board people thought. The first edition of Purposes and Functions published after the war was, I
think, written by C. Richard “Dick” Youngdahl. He went to Wall Street and became head of a
very good dealer firm, then Aubrey G. Langston and Company. Dick was genuinely smart, and
he was a great Ping-Pong player. He and I played for the Board Ping-Pong championship in my
second year, and I won because I was younger. I don’t know why, but Dick swore off of PingPong. [Laughter] He said, “I’m never going to play Ping-Pong again,” and he didn’t. Instead,
he became a very rich man. He left and went to run Aubrey G. Langston and Company.
The edition of Purposes and Functions that I helped transform—the first after the war, I
believe—stressed something called the “lock-in effect.” That was the chief method by which
monetary policy was seen to work. It meant that if you are holding a government security and
the Board tightens and the price of the government security drops, then you’re locked in, you
don’t want to sell it. Now, if you believe that, you believe a lot of things, but that was the theory.
That made no sense to me. The person who does the writing gets some input, so we got rid of
that and inserted a much more ordinary sense of how monetary policy works. I don’t remember
any theory in there. I don’t think that money supply was in then, or not very much. There was
probably more emphasis on bank credit, which was big in those days because of the New York
Fed people. I worked with Ralph on that. Thereafter, I was stuck with Purposes and Functions
yea unto the end of my career. [Laughter]
MR. SMALL. You were stuck?

2

The Federal Reserve System: Purposes and Functions provides an overview of the structure, responsibilities, and
operations of the Federal Reserve System. It is published periodically by the Board of Governors of the Federal
Reserve System.

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MR. AXILROD. Well, finally I was supervising it. I wrote the introduction and read the
crucial parts. Over time, Purposes and Functions changed in important ways. Somewhere along
the way of producing the various editions, someone said, “Now, you’ve got to put in there why
bank regulation is so important for monetary policy.” And now that fat is in the fire.
I pondered this, and I could not really think of why it was so important that the Board
have a handle on bank regulation. I remember thinking back to my undergraduate thesis on the
economic problems of the Missouri Valley. I wanted to make a Missouri Valley Authority, like
a TVA (Tennessee Valley Authority). I asked a postdoctoral student who was a resident tutor at
Winthrop House, the house I lived in. I knew him way back. He was much older, but he had
been from SMU. I went to him and I said, “How do I say it’s good to have a Missouri Valley
Authority instead of lots of different things and all this?” He said, “The only way you do it is,
you pound on the table and assert it.” [Laughter] I thought that was the answer to writing in
Purposes and Functions why the Federal Reserve had to be in banking regulation. I thought that,
if you’re into regulation, you’ll learn and know about all those issues and conditions, and it’ll
make conducting monetary policy easier. It was not extremely convincing to me then, but it’s in
there, and it sounds right. I don’t know how they’ve written it now, when it has obviously
become very importantly connected to monetary policy.
Subsequently, after I retired as vice chairman at Nikko Securities International, I did a lot
of foreign consulting under various auspices with emerging central banks. I used to suggest that
bank regulation be part of the central bank, for several reasons. First, many of these central
banks couldn’t really have an independent monetary policy. The best thing they could do was
keep a banking system generally safe and sound so people would give them capital at reasonable
rates and financial conditions would be sound enough to help, not retard, the economy. Second,

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I had the feeling that their staff consisted of the better and least politicized people in the country.
All central banks in emerging countries are quite politicized, but the central banks are often the
least politicized of all the parts of government. So central banks may be a safer place to put
regulation. It’s hard to argue, but it’s arguable, that the Board of Governors of the Fed will have
better people for regulation than the Comptroller of the Currency. Would staff at the state
authorities be better? Who knows? I wouldn’t think so, but you can’t say that. So the argument
that the Fed should be involved in bank regulation is not a simple argument to make. On the plus
side, the Board is independent, not so much under direct political influence from the
Administration or members of the Congress (possibly with the exception of members of the
House and Senate banking committees). And as recent experience has shown, the Board should
be cognizant of and, in my view, actively use regulatory policy as a stabilizing tool to
supplement monetary policy. In various countries that are developed, like some in Europe, it’s
handled differently, not necessarily all in one institution.
You could not argue now, I think, that the Board has distinguished itself in bank
regulation, looking at what’s happened recently. I tend to think that isn’t because of the nature
of the supervisory staff, or the fact that bad supervisors were brought in, or that the Board didn’t
pay enough to attract good staff. I think it has more to do with the nature of the leadership.
People who supervise work in these areas—or any other areas, for that matter—are very
sensitive to what the leadership is going to think of them. If the leadership is interpreted as
wanting to give more leeway to banks and other institutions rather than less leeway within a
particular regulation, they’ll give more if they want to get promotions. I think it’s a leadership
issue. And I don’t think the Board as a group is any less sensitive to the atmosphere of the

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country than is any other group—though it remains my perhaps biased opinion that the Fed
System performs as, or more, effectively than other agencies in the regulatory area.
There are specific instances where it may be useful to have an operational insight into
bank policies. If the Fed is in a period during which it is debating how much to tighten or ease
policy, there is value in knowing how the banking system will respond. It’s not just all in the
total reserves you put in or take out of the market. You can control that.
But once the reserves are in the market—this is the obvious situation—are the banks
going to use them, or are they going to hold them as excess [reserves]? Are they just simply
going to refuse to lend them [out]? In that case, there might be some use for a regulator in the
Board knowing very directly and clearly what the situation is in major banks or in the sum of
smaller banks or something like that. It might also have some influence on thinking about
capital requirements at banks. Should they be lowered if banks are holding back on lending, or
should they be raised if banks are lending too easily and, say, abetting the creation of financial
bubbles? Now, the Board can get that information from whatever independent regulator there is
even if they don’t have any authority. But the channels of communication may not be quick, and
there’s a lot to be said for hands-on, in some sense of the word. That’s how I wrote it up in
Purposes and Functions. Now, in light of the current crisis and its genesis, I see a lot to be said
for the Board having authority to consider coordinate action between regulatory and monetary
policy.
MR. SMALL. What kind of work did you do in the Banking Section?
MR. AXILROD. I don’t know exactly what I did. I was number two in the section. All
I dimly remember is trying to get the chief of the section, James B. “Jim” Eckert, to put out a

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seasonally adjusted business loan series, which I thought was easy to construct. I could do it
myself out of a book on statistics. In those days, there were no computers.
Another thing that happened was that one day—I guess that was about the time when I
was working with Ralph—Dan Brill came into the office and said, “Take over for Edward R.
‘Ed’ Fry.” Ed used to prepare charts on reserves and required reserves, aggregate reserves. I
don’t remember the money supply numbers being in them, but perhaps they were. “Take over
for Ed on his charts. Make something analytic for policy out of them.” These were charts Ed
would prepare for every FOMC meeting. Woodlief “Woody” Thomas, who was then the main
person on the monetary side, would distribute them. I have no idea whether he’d talk about
them, since I didn’t attend FOMC meetings at the time. There was nothing analytic in there.
That was the start of the Bluebook. One of the principal originating purposes of the
Bluebook was to fence in the manager of the Trading Desk at the New York Federal Reserve
Bank, because the FOMC made a vague decision such as: Let’s make things “a little tighter” or
“easier” or keep them the same. “Tighter” or “easier” encompassed various money market
conditions (including such things as dealer loan rates, the amount of borrowing by big banks
from the country banks) that influenced the direction of rates in the money market. But such a
vaguely specified decision left a lot of leeway to the manager.
The federal funds rate wasn’t important at that point. I think, though, it was close to the
time when the federal funds rate broke through the discount rate. For many years, the discount
rate was a cap on the funds rate. Ralph Leach, who used to be at the Board as chief of the
Government Finance Section and—I think—went to Morgan as treasurer, said to himself one day
while at that bank, “Why?” So he bid the funds rate above the discount rate, and that was the
end of the discount rate being the cap on the fed funds rate. I suppose he checked with his boss.

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A couple of other things are in the Bluebook—for instance, the Treasury bill rate, if I
haven’t mentioned it. The manager of the open market account would come into the FOMC
meeting and, for example, would say that things looked a little tighter in the markets. Then he
might add, “But I couldn’t do anything about it, because big banks are borrowing from smaller
banks.” And so that borrowing rate—the federal funds rate in today’s parlance—went up, which
influenced the rates on other instruments financed in that market, such as the Treasury bill.
So the Bluebook was an idea to put specifics in and define what the Committee
specifically means by “money market conditions.” I think the first Bluebook didn’t have any
policy in it, because this was an “even keel” period. There would be a big quarterly Treasury
financing, so there were no policy alternatives because, under “even keel,” policy would hold
steady during such a period. Then there came to be more discussion of the money supply. And
the Bluebook evolved from giving the money supply a more primary role into what it is now,
which probably minimizes money supply, I assume. I haven’t really looked at one recently.
I would guess the Bluebook now would give a more primary role to real GDP (gross
domestic product), inflation, and inflation expectations. And policy is made off projections of
the economy, which gives an enormous amount of power to the staff, rather more than I ever
had. It’s enormous.
Monetary Policy and Economic Forecasts
MR. SMALL. At that time, was there formal forecasting?
MR. AXILROD. Yes, there was. Dan Brill made the first formal forecast. It was a
revolutionary development—I can’t give you the exact year. When Woody gave briefings to the
FOMC, he did not forecast. He was telling the Committee how the economy looked. The
economy was weakening, strengthening, or changing little, but no forecast was given except

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what was implicit. I guess he could use adjectives or adverbs: “strengthening a lot,” “a little,”
and all this kind of stuff. Dan had been chief of the Flow of Funds Section at one point, followed
by Stan Sigel. Then Dan became head of the Division of Research and Statistics (R&S). The
Board was now in the process of making models, originally in concert with the University of
Pennsylvania and some other groups; later, we had it to ourselves.
Chairman Martin gave permission to present forecasts. This was big excitement. I was
not involved in that. I was always on the policy end. Chuck Partee was the director of R&S.
Lyle Gramley and I were associate directors. At that point, we both had the opportunity to brief
the FOMC. Lyle’s main brief was to work on the chart shows that embodied the forecasts. At
that early time, my main brief was to discuss current economic developments, which I tried to
put in a policy context. As time went on, that fell by the wayside for me. I got more directly
involved in policy and briefed the Committee on the policy alternatives before them. But before
then, Dan Brill was presenting chart shows twice a year. I don’t remember when the Greenbook
had formal projections in it, but the first formal projections would have probably been around
then.
MR. SMALL. My guess is, around 1967.
MR. AXILROD. That sounds about right for annual forecasts; there might have been
forecasts a quarter or two ahead a bit earlier. Then there came a time when the Congress was
going to vote on a tax increase. The Board staff was part of a Quadriad. Arthur “Art” Okun, I
think, was on the Council of Economic Advisers at the time. The Quadriad was composed of the
Board, the Treasury, the Council of Economic Advisers, and the Budget Bureau, I think. Dan
was the representative from the Board staff. Chairman Martin was the member of the Quadriad

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from the Board. The idea was there would be a tax increase, and there seemed to be something
like an agreement that the Fed would vote to ease policy if that occurred.
The Fed staff projection was made independently but, in my memory, at the time was not
too different from the Quadriad projection. Then the [1968] tax increase came, which it was
feared would weaken a none-too-vigorous economy a bit too much unless the Fed lowered the
discount rate. No one at the Reserve Banks wanted the lower discount rate. So Dan Brill went
out and persuaded the Minneapolis Federal Reserve Bank—Hugh D. Galusha was the president
then—to propose a lower discount rate. The Board has the power to “review and determine”
discount rates, but it is obviously better from the viewpoint of market perceptions and Fed
solidarity if the Board did not determine them. So there was some urgency to find at least one
Reserve Bank board of directors to propose one, and the other boards would then come along.
Anyhow, six or eight months later, it all had to be reversed. Rates went back up for a while,
because the economy didn’t slow down as much as projected. Shortly thereafter, Dan found a
job in the private sector, and I think projections weren’t thought too well of at that point.
MR. SMALL. I’ve heard that, early on, when Bill Martin was the Fed Chairman,
projections were not allowed.
MR. AXILROD. They weren’t permitted early in his tenure. I do remember Dan being
excited that the staff could now present projections to the FOMC, but I don’t remember
specifically when. I was not intimately involved in that at all. I think he might have even tried
to put flow of funds material along with the gross national product (now GDP) and related
nonfinancial information, but that never worked out well in practice. That was just too complex,
unneeded.

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As I noted in my book, Martin did modernize the economic work at the Board in the
sense that the macroeconometric model was developed and projections began. As a sidelight, I
might add that at one of the FOMC meetings in this period, Martin described his adventures with
LBJ on the ranch when LBJ took him for a ride on his Jeep in the roughest part of the ranch at
some rapid rate of speed. Obviously, it was a bit of intimidation, but the Fed continued its very
slow tightening, when inflation was picking up from the 1 to 2 percent per year range to
4 percent. I think, in the last year of Martin’s tenure, the rate was 6 percent or something like
that. So Martin may have regretted modernizing the Fed economics more than his ride in this
Jeep at the LBJ ranch. But forecasting then became the way things were approached.
I have tried to come to a judgment on what forecasting did to monetary policy. It was
very hard to conclude anything. The only time I can think of where the forecast of the economy
didn’t have very much importance was the years 1979 to 1982 under Volcker. We focused on
nonborrowed reserves, because we had one objective: Get inflation down. When I was doing
the Bluebook in that period, I cared very little about what the forecast was. Well, that’s a bit of
an overstatement, since the projected state of the economy would affect my interest [rate]
forecasts, given the money supply. And I don’t think the FOMC cared quite so much about the
forecast as it usually did at that point in time.
The Great Inflation
MR. SMALL. What are your views of why inflation took off during the 1960s? Did the
Fed have the wrong model?
MR. AXILROD. It was the last four years of Martin’s regime, and it was the Vietnam
War, so defense spending went up. I was chief of the Government Finance Section early in that
period. I know for sure that we could not get good defense spending estimates from the Budget

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Bureau or the Defense Department that probably had them. You can’t just, on your hunch that
the figures on spending were being repressed, raise your government deficit forecast and its
effect on interest rates. They had this model, and what do they do?
MR. SMALL. Add factors?
MR. AXILROD. Add factors. They are used to raise or lower the curve implicit in the
model’s forecast. Well, that wasn’t so quickly done in those days, and you do need some
objective evidence, like a sustained record of consistent misses in forecasts. I don’t think you
can easily argue it on qualitative hunches. So I think their GDP forecast—I don’t have the
evidence—was probably weaker than if we had had good defense data. But no one could get
good defense spending estimates.
If we had had the proper forecast, would the Fed’s policy have been more aggressive? I
can’t quite answer that question, but then the real funds rate was positive, which was a plus. It
was in the area of 2 to 3 percent, which is not as it was under Arthur Burns when it was negative
or under Alan Greenspan when he was starting into this business of enhancing moral hazard of
markets by saying publicly that interest rates were going to stay low for a long period, when the
real interest rate was also negative.
So, yes, they did fight inflation under Martin, but I don’t think they had an adequate
forecast from the staff to show them how bad the situation really was. I’m not sure of that,
because I don’t have it in my head or any evidence on what the actual forecast was relative to the
outcome, which is what one would need. But I know for sure we didn’t have adequate defense
spending figures. They were revised all the time. Maybe we should have just done it, but it’s
hard to do. So that, I think, is the fundamental reason.

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But also, all through the 1970s, there were Regulation Q ceilings on interest rates offered
by depository institutions. The slowest boat among the institutions was the S&Ls, because of
fixed-rate, long-term mortgages. They weren’t variable-rate mortgage loans. So you couldn’t
raise Regulation Q rates readily along with inflation to high levels: That would have driven the
S&Ls into bankruptcy in that period.
Back then, many policymakers believed that Regulation Q was a policy instrument. So
when you hold it down, you’re forcing banks to ration credit. You would thereby put less
upward pressure on market interest rates, and you would still get policy restraint. That was a
firmly held belief.
MR. SMALL. Disintermediation was a big issue then?
MR. AXILROD. Well, it wasn’t occurring much yet, though it was certainly on its way.
Interest rates would go up, but you’d get more restraint allegedly at a given level of market rates
because banks would ration credit, and nonbank sources of borrowing, especially for smaller
borrowers, had not yet developed to the extent they now have. But, of course, the market
changed, and that wasn’t very useful after a while.
Two former Board employees, then on Wall Street, came to Washington to have lunch
with me at the Board. They said, “You are probably the only person down here who will
understand this. You can’t give up on Regulation Q because the banks can make better
judgments about adequacy of borrowers than the market.” So that was among the factors that
were thought at the time to make bank credit a powerful instrument. Many people at the Board
thought that; the New York Fed was the hotbed of such thinking. The emphasis on bank credit
was important in Win Riefler’s early book on money markets.

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The Fed did a half-good job. At least it kept the real interest rates from dropping. Rates
were about where they were in the early part of the decade. But demands were stronger, so the
real interest rate ought to have been higher, but it wasn’t. So the Fed did a half-good job—a
much better job than in the 1970s. The only thing I could really operationally think of as a cause
is that we did not have adequate defense spending estimates, and our projections of the economy
did not show enough strength. But that’s just thinking. I don’t know for sure.
MR. SMALL. Did you have a sense that the economy was close to potential or full
employment?
MR. AXILROD. I don’t remember anyone ever thinking of the word “potential,” nor do
I remember anyone using the term “real interest rate.”
MR. SMALL. “Natural rate of unemployment?”
MR. AXILROD. I don’t remember exactly when that came in, but I think a real problem
was that we didn’t think about the real interest rates in the way we should have. It was bad, in
my opinion.
Chairman Martin: Advisers and Political Pressure
MR. SMALL. Did you know Win Riefler?
MR. AXILROD. Yes, but not well. He was the number one guy when I arrived as a
GS-7. I was flattered because, after a few years, some person who was important in R&S then
said, “You start, in thinking about policy operations, just where Win Riefler starts in his
thinking,” which was free reserves. That’s because that’s all you could affect through open
market operations. You can affect either nonborrowed reserves or free reserves. You can’t,
through market operations, affect anything else insofar as bank reserves are concerned. So I

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started with what was going on. In any event, it was something like that. I then got from free
reserves to the money market conditions.
But, yes, Win was there. I vividly remember meeting him in Ralph Young’s office about
some subject that Win was there to discuss. Ralph was saying that he didn’t want to do what
Win was suggesting, and I remember Win saying, “Well, the best defense is to be offensive.”
[Laughter] But Win was a really nice man.
Win was an adviser to the Chairman. He must have influenced Martin. At one point,
Martin brought in a man named Jim something or other from North Carolina—I think Riefler
was gone. This guy sent shudders along the spines of people like Ralph Young and whoever was
really in power then, because Martin would pay attention to him. He was not a very good
economist, but Martin’s bringing him in indicated some discontent on the part of the Chairman
with what the staff was delivering him. That’s all I remember.
Win was thought to be a power, and his book was a guiding light of the modern
free-reserves idea, which Win interpreted as influencing bank credit availability mainly through
changes in member bank borrowing at the discount window. 3 The New York Fed people were
big on that. We at the Board weren’t, or at least some of us weren’t, and when people said to
me, “Bank credit is doing this now,” I said, “Yes, but look at the money supply. That’s what’s
causing interest rates to go up.” Well, it just depends on your theoretical thinking and your
intellectual background, that kind of thing.
MR. SMALL. Do you remember hearing stories of the political pressure on Martin in the
late 1960s?

3

Winfield W. Riefler (1931), Money Rates and Money Markets in the United States (New York: Harper &
Brothers).

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MR. AXILROD. No, all I remember is that story told at the FOMC that I mentioned. I
had no real knowledge of how Martin reacted to political pressures. None of it seeped through
other than that one story. It was in the later part of his chairmanship that I started going to
FOMC meetings.
Once he asked me to go with him to a congressional hearing. That was really unique,
because he never took staff. I was just a kid in my early 30s. I can’t remember the exact year. It
would have been maybe a year or two before he left. On the way over, he said, “You know, if
this money supply comes up, you’re going to have to answer the question. It’s going to become
important at some point.” But it didn’t come up, and I wasn’t asked a question. I suppose I
would have stumbled through an answer.
Martin was a good Chairman. He convinced the FOMC to keep tightening despite
Lyndon Johnson’s attempt to scare him to death driving through all these rocks in his ranch in
south Texas. Martin was a straightforward guy. And he ran a very good Committee. He was a
good tennis player. I learned tennis playing with him and watching him. I didn’t play much
before that. But, as to political pressures, I know not how they came or to whom he talked.
The Burns Chairmanship and Inflation during the Burns/Miller Era
MR. SMALL. In FOMC meetings, did you witness a change from Martin to Burns?
MR. AXILROD. Oh, yes. By then I was number two on the R&S staff. I don’t know
how you’d count Lyle or me, but I had the office next to Chuck Partee. So we were both number
two in different areas.
Yes, that was a distinct change, and that was a distinct change in atmosphere at the Fed.
It was another world. Arthur Burns was a gruff academic. He wasn’t smooth except when he
wanted to be with his bosses or whoever was above him. When Burns came, Chuck Partee went

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down to his office to talk to him. [Laughter] After, Chuck reported—in my memory, I was
there; I suppose Lyle was there, but I can’t remember who else—that he had resisted something
Burns wanted to do, and Burns said, “I have lots of people in New York I can get up here to do
this sort of thing.” [Laughter] Anyhow, the atmosphere changed. It may be that I never noticed
it before, but by then I was among the top two or three in the policy area. You’re closer to the
Chairman and the pressure is on and all that, which you really don’t notice otherwise.
MR. SMALL. Did Burns drive the staff hard, as far as wanting input?
MR. AXILROD. Oh! Well, yes. Burns was perfectly capable of his questioning being
quite tart with some poor guy at a staff briefing of the Board and making clear that the young
man didn’t know what Burns wanted him to know. In fact, when I was a section chief, I took it
as part of my task to be sure that no one—no matter how good he was—got up there if I felt that
it was going to hurt him. Burns was a good economist, and he wanted good staff work. Martin
wanted good staff work, but he had to rely on the economists to know who was a good
economist. He could judge who was a good person and who seemed to know what he was
talking about. Burns was a good economist, and he knew bad work when he saw it, so you had
to be very careful.
I remember I had one bad experience that was my own fault. I sent something to him. It
didn’t go well, and Burns was infuriated. I think it was Bob Holland who brought it back and
said, “You know, the Chairman doesn’t like this.” I looked at it and thought that instead of
writing a B minus paper, I’d better sit down and get it at least up to A minus. [Laughter] I
revised the paper, and it became a very good paper. Burns taught me a lot. In school, I made
very good grades, but I didn’t work hard. I was sloppy. I didn’t like to study hard and work
hard. Burns taught me, in many ways, how to think and forced me to think harder. Don’t be

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happy with the first or second draft. B plus, A minus wasn’t good enough. In those days, those
were still rare grades, certainly at Harvard. Burns did a lot for me in that sense. So I had more
tolerance and admiration for him than a lot of people did. He had a big-time temper that partly
was natural to him and partly was used for getting his way. I faced it, though quite rarely. Other
people who faced it were less up to facing it. I knew I was valuable to him and they didn’t, so it
was tougher for them. I thought Burns improved the economic analysis presented for policy.
That was a positive.
Burns also made FOMC discussions much better, because the first thing he did was stop
Reserve Bank presidents from reading a dreary paper on conditions in their District that was
prepared beforehand and circulated as what’s now the Beige Book—in those days, it was the Red
Book. Secondly, Bill Martin had an order for the FOMC meeting. He’d go around the Board
table calling on people this way one time, and then he’d go around the opposite way the other
time. Burns stopped that. He had the members just speak up in general about the national
economy in whatever order he saw their hands raised. That made it a little more informal.
MR. SMALL. I’ve heard of other changes. Martin used to always speak last, and Burns
spoke first, correct?
MR. AXILROD. Burns did speak first. And, yes, Martin did speak last.
MS. CARTER. Martin was the Fed Chairman from 1951 to 1970, during most of the
34 years you had been at the Board.
MR. AXILROD. Yes, 18 years. He became Chairman the year before I came.
MS. CARTER. This had been a period of institutional stability, and then the
chairmanship changed.

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MR. AXILROD. I was high enough by then to see the change. Chuck Partee was the
director of R&S. Lyle Gramley and I were associate directors at the time of the transition from
Chairman Martin to Chairman Burns. How was Burns going to treat us economists? He made it
clear quickly that we better pay attention to him, and that was that.
In my experience, the staff pretty much ran itself. It was essentially a merit-driven staff.
It wasn’t determined on a political basis by the Board but was based on the talents and
experience of the staff members. When we had Chuck’s office, it was called the Office of the
Managing Director for Research and Economic Policy. He was supposed to manage
international as well as research, but that never quite happened because of various turf issues
within the Board staff. When Chuck Partee became a Board member, they changed that to
Office of the Staff Director for Monetary and Financial Policy. That was me. I didn’t have
anyone in there except a deputy, the secretary of the FOMC, and perhaps three or four others. I
had access to the whole staff, the Legal Division and all that. I was also head of a discount
policy group and a reserve requirement policy group. Eventually, Chairman Volcker wanted me
to be secretary of the FOMC as well as staff director. I tried to argue against that, but he
remembered when Riefler was FOMC secretary. He thought he’d want a person with some
economic stature there, and by that time, I had some kind of reputation. So I had, except for
Paul, all the power in my hands. That’s a joke, of course. Don Kohn was my last deputy. In any
event, the office disappeared after I left the Board in mid-1986.
My initial title was Staff Director for Monetary Policy because it was only domestic.
That included Regulation Q and all that jazz that people thought of as monetary policy. At that
point, I got Ed Ettin as deputy, because he was good on Regulation Q.

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Then, under Chairman Miller, I was given responsibility—the Board voted for it—for the
operations in the foreign exchange market, and that eventually came to include Eurocurrency
issues. But it was technically broader than that also, including something that could be
interpreted as working with the IMF (International Monetary Fund) for international exchange
payments policy-type questions—not just operations. I ignored that, and all I did, practically,
was the foreign exchange market operations, for which I had a phone call every morning with the
people at the New York Reserve Bank, and also worked on certain Eurocurrency issues. I
reported to the Chairman on day-to-day conditions in the foreign exchange market. Once in a
while, after checking with the Chairman, I would call the Treasury and say, “We’d like to do this
in the exchange market.” They’d say, “No,” and I’d go back to Volcker and say, “Of course,
they said, ‘No.’ ” But we had at least made a point. In any event, the manager for foreign
exchange operations at the New York Fed, before he could do anything, had to call the Board—
mainly the Chairman, of course, but also me. Then he had to call the Treasury, who pulled the
trigger and usually initiated the policy. It was complex.
I believe I was the only person who ever had that joint domestic and international market
responsibility at the Board. In New York, they combined the foreign exchange and domestic
market operations under Alan Holmes, then Bill McDonough also had it.
In order not to give the impression that monetary policy was closely connected with
international exchange market policy, which it really wasn’t, the office was named “Monetary
and Financial Policy.” That designation made it sound a lot broader in some ways than it
actually was. After Alan Greenspan took over, the new Division of Monetary Affairs took over
all the functions of my old office, except the international ones, plus it also came to include the

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relevant financial sections of R&S. And the dreaded word “policy” was removed from a staff
office.
MR. SMALL. Burns came in with a reputation of being an inflation hawk, kind of like
Martin did, but he left with inflation even higher.
MR. AXILROD. Well, Martin wasn’t that much of a hawk. I think inflation was
4 percent to 6 percent at the end of his term. So there was already some inflation and
expectations in there when Arthur Burns came in.
My conclusion on all this is that you can’t tell a Chairman’s policy tendencies in advance.
You knew his qualities as a person, and you’re close enough to him. I played tennis with Martin
almost every day and got to know him quite well. But the Chairmen were in different
environments. Greenspan was in some ways in the easiest environment, until it exploded late in
his term, and Ben Bernanke ended up with the toughest economic and financial environment. To
some degree, parts of these environments were self-inflicted. That being said, Martin was in a
fairly easy environment. Burns was in a very difficult environment in the sense that he had a
country that was divided politically and in which there was apparently little support for tough
measures to reduce inflation. The 1960s social revolutions were still very important in the
1970s, and pressures on savings and loan associations were beginning to emerge.
We still had this darn Regulation Q. So if Burns tightened a lot, he was going to drive
the S&Ls out of business quickly. We didn’t have variable-rate mortgage loans in there.
Somewhere along the line—I don’t remember if it was under Martin or Burns—the Penn Central
crisis occurred, and large CD rates were permitted to go up. I think they were the first ones. So
gradually things were occurring. The loosening of regulations on financial institutions was
taking its first baby steps. It was when I was still in the Banking Section, I think.

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MR. SMALL. The Penn Central crisis occurred in 1970.
MR. AXILROD. When did Burns arrive?
MS. CARTER. Burns became Chairman on February 1, 1970.
MR. AXILROD. Yes, so Burns had Penn Central. The CD rate ceiling was increased
because Penn Central was under pretty severe liquidity pressure. It was thought that would
improve the ability of banks to raise money through large CDs and lend to Penn Central, which
would provide some relief for the company.
Apart from threats to the stability of financial markets if inflation was fought
aggressively, the country as a whole didn’t seem as if it would tolerate the very serious recession
it probably would have taken to get inflation noticeably down. In those days, labor-cost
pressures were tracking the inflation rate, and a sustained rise in unemployment would probably
have occurred as market forces brought them in line with a significantly lower rate of inflation.
The next burst of inflation was under Chairman Miller. There were two oil price spikes.
One was under Burns around 1974. The other was under Miller in 1978 or 1979. In some sense,
if you compared the United States with other countries, other than Japan, I don’t think Burns was
all that bad. There were three, four, or five years, in my memory, of 6 percent inflation or more.
Then there was that spike of 10 or something. It doesn’t look good in retrospect, and it was bad
enough. But what he was really bad at, I’ll note that later. Do you have the inflation rates of
those years?
MR. SMALL. I have the Greensheets from the Greenbooks—gross business product
fixed weight price index from 1974 through 1978. From the April 1978 Greenbook: In 1974 it
was 10.4 percent, then 9.5, 5.4, 6.0, and then forecasted to be 6.6 percent for 1978.

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MR. AXILROD. Yes, that’s right, and then it goes up again. Those are the 5s and 6s
that I remember, 6s, and then early on you’d have found some very low ones in 1971, 1972, and
1973. Maybe they started going up in 1973.
MR. SMALL. From the February 1975 Greenbook: In 1971, it was 4.3 percent, and in
1972, it was 3.3 percent. Then in 1973, it was at 6.3 percent, and in 1974, it was at 11.4 percent.
MR. AXILROD. Yes, that’s it. So, in a sense, it wasn’t quite as horrible as people
remember, except for that spike. I think there was a minor recession at the spike. The Open
Market Committee simply chose not to fight inflation strongly and cause enormous
unemployment. That’s how I look at it. It just wasn’t nearly as horrible as people think except
for those three years.
What Burns did that got the Fed in real trouble was to say, “I’m going to control inflation
by controlling the money supply.” But then it became obvious that we were not controlling the
money supply. In fact, we were, in effect, lying. Well, we were not exactly telling the truth,
because we had what was called “base drift.” We would say, “Here’s our target for the money
supply, based on the first quarter, for a year ahead.” Then money growth in the first quarter
might turn out to be above target. We would then forgive that and base our target for the year
ahead on the next quarter—the second quarter, in this example. That approach began to be
called “base drift” because it permitted the money supply to continuously rise. It would
continuously drop if it ever fell. This was considered a bad thing, and the Fed’s monetary
reputation lost credibility. And since inflation came back up in 1978 with the next oil crisis, that
credibility was twice lost, in a sense. So the fact that Burns alleged and gave the feeling that he
was controlling the money stock, and we, in fact, weren’t, by the way we were operating—

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coupled with inflation staying too high—there was no more credibility for the Fed. So that kept
inflation expectations—and, to a degree, interest rates—up.
MS. CARTER. Is that something you were all aware of at the time?
MR. AXILROD. Of course we were. But we were not quite aware of the extent of
cumulative negative impact. We didn’t pay enough attention to real interest rates. In fact, I
remember someone in a key position saying, “We’ve got to worry about the real money supply,”
presumably fearing there might not be enough money to support real economic activity. Now,
that caught even my ear as something not to worry much about in the circumstances. But the
real interest rates, we didn’t pay enough attention to them, even though they were very negative
at that point. I used to talk about the real return on capital every once in a while: We’ve got to
get interest rates above that. I remember doing that, but I haven’t read through anything where I
might have said that. Anyhow, I think that not paying enough attention to real interest rates in
judging whether policy was appropriate for containing inflation was both a staff and an FOMC
mistake.
But I don’t think it would have mattered, because fundamentally I didn’t detect a will to
face up to the strong recessions that would have been inevitable in controlling inflation more
strongly under the conditions of that period when unit labor costs were running so high. You had
to get them down. That’s basically how I explain the failure to fight inflation harder.
Then there were all sorts of technicalities about misinterpreting the money supply
because of ongoing shifts in the country’s demand for money. The staff didn’t catch onto that
fast enough, and by the time we caught onto it, you had to convince the Board. That takes
another year. And by that time, the demand for money seemed to be back on track. But the
money stock had already risen to levels that accommodated inflation, because the Fed had not

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adjusted targets to the fact that it had already gone off track. Then, as I remember, it went off
track again.
There’s a lot of stuff that goes into the loss of the Fed’s anti-inflation credibility, but,
fundamentally, we didn’t get inflation down far enough. Then, unfortunately, we had that last
burst from the second oil price crisis. That was under Miller, not Burns. That was during the big
foreign exchange market crisis that went along with it, all of which was followed by Volcker’s
arrival. So that’s my explanation of attitudes toward inflation and related monetary operations
during the Burns/Miller era.
But I do have this problem that it’s hard for me to think of people outside the context of
their times. And it’s wrong to think of them outside their context. If Arthur Burns was in when
Alan Greenspan was in, Burns might have had a very easy time, for all I know.
MS. CARTER. What would he have done during the 1987 stock market crash?
MR. AXILROD. Alan did right. He eased off like crazy.
MS. CARTER. Right, but how much of this is the personalities versus the times?
Fed Chairman Volcker: Early Acquaintance
MR. AXILROD. Well, the only person who was unique was Paul Volcker. I think that
what we did during his chairmanship was unique to Paul having that position. I don’t know
whether earlier in the 1970s he would or wouldn’t have done what he did.
But when he became the Fed Chairman in August 1979, there was political support for an
aggressive approach to reducing inflation in the sense that, importantly, things had changed.
First, consumers were getting high interest rates in money market funds, which they couldn’t get
in the 1970s except gradually. Second, that defused the pressure from the House banking
committee, which traditionally is sympathetic to interests of small businesses, small borrowers,

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and agriculture and wants to keep rates down. The higher rates consumers could get by investing
their savings in money market funds were a countervailing political influence. It was a more
evenly balanced set of circumstances. The social and economic costs were balanced, so that was
much better when Paul came in. Third, it became evident that inflation wasn’t getting you
economic growth. Things were pretty bad in the eyes of the public as a whole, and the Congress
was more sympathetic, so Paul had all that.
Also, Paul had a kind of courage that you don’t often see in people. He is a very cautious
man. And he doesn’t make decisions until the last minute. People used to say that Paul would
never make up his mind. I never understood why you should make a decision before you had to.
It didn’t seem obvious to me. Anyway, what he did was courageous, because there was a lot of
risk, something of a leap into the unknown, with opposition waiting to pounce.
He was sort of giving in to the monetarists, but they didn’t like how he was doing what
he was doing, and he had to work hard to persuade the FOMC. I don’t know what he said
individually to each of the members of the Committee. Of course, they were ready for
something, because they were on a committee that was losing public stature like crazy because of
the policies under Arthur Burns and Bill Miller, whether or not it was their fault. So they were
ready to accept something radical, which this was. And I think Paul had stature and the
intellectual capacity to understand and oversee it, so they could have confidence in him that he’d
do it as effectively as possible.
I’m largely eliminating Bill Miller from this conversation. He was Chairman between
Burns and Volcker. That was an interesting 18 months, but I don’t know what I can particularly
say about that of any general interest.

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At some point when Paul first arrived, I went to his office and recall saying that any time
he decided to implement his “practical monetarist” position he had been taking in earlier
speeches, let me know, because I believe I know how the staff can do it. I had known him for
some time off and on. We were not quite good friends, but we were friends. When he became
undersecretary of [the] Treasury, he used to call me during his first days in office and ask what I
thought about debt management until he got used to it himself.
MS. CARTER. So you knew him at Treasury too?
MR. AXILROD. We had known each other, but he had better positions than I had. He’s
smarter, he should have. I had known him as undersecretary. I used to write memos on debt
management for the Fed Chairman when he went over to discuss such issues with the Treasury at
the times of the large quarterly financings. I used to always argue in the memos, “Don’t issue so
many long-term bonds in a weak economy. Issue short-term debt and leave the long-term market
open for the private sector.” I would argue that even now.
1979 New Operating Procedures
MR. AXILROD. Going back to Volcker as Chairman and his new policy procedures,
Paul must have convinced all these people when he took on this procedure, which was untried.
A long way back under Arthur Burns, I was chairman of a staff subcommittee for a Committee
on the Directive. I guess Sherman Maisel was chairman of the principals’ committee. The staff
voted for nonborrowed reserves and M1 as the way you should run monetary policy at the time
merely because that was sensible and seemed like a more direct way of restraining inflation
through closer control over the money supply. Well, I really don’t know the underlying reasons
why any one individual voted. There was one dissent, as I remember. That’s what impelled my
comments to Paul when he arrived, that we knew how to achieve better control over money.

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Then one day, I’ve forgotten exactly when, Paul came into my office and said, “I want to
go ahead with this, and I need a memo for the Committee to do it.” Then I said, jokingly, “I
presume you mean I’ve got to stay here and write a memo for this thing?” [Laughter]
Paul was going to Yugoslavia for an annual IMF meeting. I had gotten myself on the
U.S. delegations for a few years mainly just to go to circulate and understand how officials at
other central banks were thinking. I wouldn’t have minded going to Yugoslavia, but I was in
reality at best a fifth wheel on the delegation. There was no strong or pressing need for me to go.
That was not an issue. I stayed back and wrote a paper along with Peter Sternlight from the New
York Fed. Recently, Paul asked me, “Who’d you work with?” I said, “Geez, Paul, I don’t
remember.” I know Peter and I did the paper. I know I got something from Peter. I think he
wrote the back part. I think it was an attachment. He wrote the operations part and I wrote the
introductory part that explained the policy reasons and general approach. But I have forgotten
who—given the secrecy of the project—if anyone, I worked with on the document as a whole.
MR. SMALL. Tom Simpson recalls, as a young economist here, functioning as an
assistant, gathering statistics and the like on that project.
MR. AXILROD. I don’t know with whom I wrote that. I think I wrote it myself. The
only person I used to write with, and who I liked for doing that, was Dave Lindsey. When I got
Don Kohn as a deputy, I thought of Dave and him as a team. Don did markets, and Dave did the
analytic-type thinking. But I don’t know with whom, besides Peter, I wrote this paper.
MR. SMALL. Tom Simpson remembers being in your office when Volcker called from
the plane.
MR. AXILROD. That phone call was funny, because I could barely understand a word
that Paul was saying. He was on Air Force Two. He wanted to know that I was getting the thing

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done. I would say “yes” to any number of things, but I wasn’t quite sure what I was saying “yes”
to, because there was so much static on the line.
MR. SMALL. What about this idea that Volcker got chastised at the Yugoslavia
conference and then thought of this new approach when he came back?
MR. AXILROD. That’s absolutely wrong. He knew he was doing it when he left here to
go to Yugoslavia. He had done the groundwork with the FOMC members, I believe. We didn’t
bring it up formally to them until the day before the vote. I think we sent papers out. I
remember the Saturday and going to the FOMC meeting, but I had forgotten the Friday
conference call of the Governors and Reserve Bank presidents. At the regular FOMC meeting
three or four weeks before, we didn’t bring it up with them, or so I remember. Then this paper
explaining the proposal got sent out to them for the conference call, if I’m remembering
correctly. As I think back on it, it’s wild, because it was for them a leap into the great unknown.
That Paul had the courage and nerve to do this was wonderful. And he was relying on me. What
it amounted to is that he was taking my word that it would work. In a way, I was so naïve. I
didn’t really internalize the pressure that was there. It just did not occur to me that this was a
major big deal.
MR. SMALL. But when interest rates shot way up, you must have known.
MR. AXILROD. Yes, but it’s a job. You do your job. [Laughter] But seriously, I
didn’t fully realize the enormity of what we were doing. We were putting in place something
that had never been done before. It had enormous impacts on the economy. There was a Board
meeting shortly after they did it. The funds rate was at 8 percent. It was an executive session, so
there were only a few Board members and me, and maybe Jim Kichline. Some Governor asked
me what I thought interest rates were going to do. I thought I was very brave. I said,

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“15 percent” for the funds rate, and the Governor gasped. As I think back, that answer was
stupid, though it seemed to be brave. What was I thinking? I must have been thinking inflation
12 percent and real growth 3 percent, so a nominal interest rate of 15 percent. But you also had
to get rid of high inflation expectations and have a real rate high enough to show determination.
I should have added some more to my estimate of the nominal funds rate so that the real funds
rate would be noticeably above 3 percent. The nominal funds rate actually peaked in the
neighborhood of 20 percent, I think. Anyhow, I had not thought until that moment what interest
rates would be. I was quite confident that we could do this, but it has lots of little technical
things in there, all of which are discussed in my book in one way or another. Many of them are
interesting.
Among the broader problems we had during the Reagan Administration was with an
undersecretary of the Treasury named Beryl Sprinkel. He was a nice person personally, a
pleasant man, but he was an ideologue about monetary policy. The last thing I am is an
ideologue. My view is that you use everything you’ve got to solve a problem. It’s not one thing
that will solve your problem. Beryl was going out and saying we were doing policy wrong. That
doesn’t help. It’s like saying now you don’t know how to control the credit crisis. The crisis
gets worse when people think you don’t know how to control it, which is what can be happening
now as we are talking, actually.
It was important for people to have confidence that we knew what we were doing in
controlling inflation. Someone at the New York Fed went out and gave a talk and said we were
going to experiment with this new policy operation. Paul had a fit. He said to me, “You’ve got
to get up to New York and give a talk to those dealers. Tell them we know what we’re doing and
we’re going to stick to this thing.” So I went to New York and gave a talk. “We know what

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we’re doing.” I explained why we knew what we were doing. “This is not temporary.”
Although when it was first adopted it was subject to review, everyone knew that it would
continue unless it blew up in our face. That was what we were going to do.
Then Paul went around the country saying we were going to stick to it. Because he
would continuously say those or similar words, I thought that it was getting to be a bit silly, but
he was absolutely right. It was important to convince the market that we were going to stick to
it. It was even more important to convince labor unions and businesses that we were going to
stick to it, so that they would do whatever was necessary to keep down labor-cost pressures in
order to minimize the recession that was bound to occur as we tried to get inflation down from
12 percent to what I thought would in practice be about 6 percent. That was in my head. I don’t
know if it was in anyone else’s head. We eventually got to around 4 percent or some such value
at around the bottom of the recession.
Eventually, the Administration seemed to stop Beryl from speaking so much about our
policy. But the monetarists didn’t really believe we knew what we were doing. A little working
group was formed in the government. I don’t know what they called it, but the group met for
breakfast once a month, maybe. The group was unofficial. It included, among a few others, the
undersecretary of the Treasury, someone from the Budget Bureau, and a couple of Governors
from the Board—both Republicans—and me. This was in the early days of the new
Administration—a Republican Administration. The purpose of the meetings was not to discuss
policy. It was to discuss how the Fed was doing its operations. Though the Governors were
there, I did practically all the talking from the Fed side, because we were supposed to be
discussing operations—which was my field—not policy. I remember many conversations with
Beryl Sprinkel. I would say something like, “This—this—see—and then that!” And he would

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not accept “and then that.” [Laughter] What can you do? We can only control nonborrowed
reserves. We can’t control borrowing. We can’t tell the FOMC and the guy at the New York
Trading Desk how to control borrowing—all he can do is control open market operations.
The paper distributed to the Committee discussing the new operating procedures gave
total reserves its due. It indicated that the nonborrowed reserves path could be changed if total
reserves were growing too much to keep money supply on target, that kind of stuff.
We made the effort I just mentioned to communicate at the operational level, with two
Governors there just to give Republican solidity to it, and me. Everyone was everyone’s minder,
because everyone knew I had to go immediately back to Paul and report what was said. So that
was another effort to communicate. By the way, I also did a lot of communicating with
academics and other central bankers.
MR. SMALL. What would you say are the main selling points of using the monetary
aggregates in that way? People have mentioned internal Fed decisionmaking, having deniability
on interest rates.
MR. AXILROD. No, not the latter.
MR. SMALL. That was a popular belief.
MR. AXILROD. I know it was. Well, you can’t tell what was in any one voter’s mind.
One of them, not from the Board, did publicly say something like that. But you have to be
extremely innocent to believe that the Fed is not responsible for the federal funds rate. You have
to believe something like the janitor telling you, “I am not responsible for the lack of heat
because I only go by the thermostat.” The Fed balance sheet—the monetary base, the total
balance sheet—is what gives the Fed the ability to raise and lower the funds rate, at least until
recently. [Laughter] So if you’re going to operate with nonborrowed reserves as your lever,

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eventually it’s the monetary base that you control, presumably better than otherwise. The Fed
can control that one way or the other, and, therefore, it affects the funds rate.
If deniability on interest rates was important in any one voter’s mind—or two—I don’t
know. I know one, but I don’t think that’s important. And given the fact that I was asked by a
Governor what I thought the interest rate would be, he must’ve known we had some effect on
interest rates here. [Laughter] But you’re talking about public deniability, and I don’t think that
was important.
What was important in my mind—I can’t speak for Paul—was that we needed to do
something to overcome the great amount of policy credibility that was lost in the previous
regime. Part of it was because earlier we claimed we were controlling the money supply and
weren’t. We needed what I would call a “paradigm shift” to make it clear to the public that it’s a
new slate. We needed someone with real authority, which Paul could evoke, because he knew
what he was doing. He wasn’t just giving a speech about what he was doing that someone else
wrote. I used to go to him and say, “For goodness sake, Paul, write the draft so I can get it
checked.” If someone else wrote a first draft, he usually didn’t like it, especially if it was closely
related to policy. So I think it was that combination of a paradigm shift and a man who could
give the feeling to the public that it wasn’t a stab in the dark. We were doing it, we had a reason,
and this reason was going to work.
At the beginning, it was a little bit messed up with the credit control program. That’s a
detail we don’t have to get into, but it did mess things up at the beginning. But the new
operating procedures seemed to be working. Interest rates went up a lot. We weren’t any longer
just controlling the funds rate by ¼ percentage point; we gave it a lot more breathing room. For

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a while, the money supply actually calmed down as we wanted. Then the recession came, and it
jumped like mad, and we got off of it.
So I think emphasizing the monetary aggregates was for the reason—I guess I’m trying to
express it—that we wanted to regain our credibility. Without that credibility, it would’ve been
very hard to control inflation as quickly as it turned out we did.
What was instrumental as well, in the control of inflation, was the air controllers’ strike
and Reagan breaking that union. I grew up in my youth singing “Sticking to the Union” and all
that stuff, so I didn’t meet that with great joy. But by that time, anything that would work was
welcome.
I think that’s what motivated the shift to the monetary aggregates—the need to get it
done, to get inflation under control, and by no means to duck responsibility for what would
happen to interest rates in the interim. And the political environment was acceptable. I guess
that was the time Volcker got all those wooden planks—but that was minor. 4 That was nothing
compared with the possibility that a chairman of the House banking committee might say, “I’m
going to take your budget over and make it subject to the appropriations process.” You can
survive a few pieces of lumber. The main thing was, we’d just run out of believable weapons to
control inflation and we needed another one.
MR. SMALL. Did you think regaining credibility was more difficult and took longer
than you thought at the outset?
MR. AXILROD. No, I think it took a lot shorter [time] than I would’ve thought. Let me
put it the easy way: With what we did, we got the credibility faster than we otherwise would
have. When you play the game of how long would it have taken, under the earlier operating

4

During the period of high interest rates, homebuilders sent 2x4s to Volcker’s office with messages that they would
not be needing them.

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procedures, to get the funds rate up to 20 percent, as we eventually did, that would have taken
quite a while longer without the new procedures. While I would’ve said we might need a funds
rate of 15 percent, I don’t think I would’ve had enough nerve to recommend it so quickly. And
if I’d have told the Chairman, “I’m going to put in the Bluebook an option that says, ‘Option A,
15 percent for the funds rate; Option B, 8 percent; Option C, 7½ percent,” I don’t think he or any
other member of the Committee would have liked that or even thought I was in my right mind. I
just don’t think we could’ve raised the funds rate at the speed we did without the shift towards
the monetary aggregates.
Now, that’s going to the argument, which is a reasonable argument, that policymakers
change their instrument very slowly. Let’s call the funds rate the instrument. So they change it
slowly—a quarter point, a half point—and that’s not unreasonable, because unexpected things
happen. The odds are that, if you change slowly, you’re more likely to be in the right position
when something unexpected happens than if you change it rapidly. If you make the money
supply (M1) the policy instrument, which is what we did as reduced to a nonborrowed reserves
target so you have an M1 target—it’s a nonborrowed reserves representation of it. You don’t
have to change your target very much in an instrumental operating sense. That solves the
psychological problem of moving your instrument too slowly, which means, in effect, you get
the interest rate moving more rapidly.
I think we adopted a plus-or-minus 2 percentage point range, so there was an overall
4 point range for the federal funds rate. Consultation with the FOMC would be required if it
were necessary to breach that range in order to hit the nonborrowed target. Then I think it was a
6 point range for a while, and then it went back to a 4 point range. So you have a fail-safe device
in there, but the range was not supposed to be a stopping point—it was a checkpoint between

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FOMC meetings. If the funds rate needed to move outside the range, the Committee would vote
and say, “Okay, let’s go ahead.” Only once do I remember it being a stopping point, which was
on the downside during the credit controls program.
So, in a sense, if someone says the new operating procedures were to avoid responsibility
for interest rates, you could say, rather, it was a procedure to let interest rates go, to set the
conditions where they would move more rapidly. That’s how I think of it. It certainly did not
mean the Fed had no responsibility for interest rates.
If I were weighting all the things that went into the reasons, I would give the least weight
to a pure monetarist argument, which implies to my mind something like a black box out there—
like if you control the money supply, policy will, through some market process or other, work
well. I would give more weight to the argument that it would permit us more rapidly to move the
interest rates up and down as needed. I’d give some weight to the monetarist argument but most
to the flexibility of interest rates it implies. I would give no weight at all to it being a way to
avoid the Fed’s responsibility for interest rates.
MR. SMALL. What about a commitment effect that once the FOMC selected these new
procedures and put out a money supply number, there’s almost no turning back?
MR. AXILROD. Yes, that’s what made it so good. One question I had when we did this
was, how do we get off it? And it turned out to be an accident. In the recession, a very large
quantity of, as I remember, nonrenewable instruments termed Small Saver Certificates—or
something like that name—matured. We didn’t know how much of the funds would go into
demand deposits and how much would not and, therefore, how much the M1 measure of the
money supply would be affected. So we declared a moratorium on focusing on the money
supply. The moratorium never quite went away. [Laughter] Then it also began to look like the

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interest elasticity of money demand was wildly high. That made money less good as a
stabilizing instrument. We gradually got off it, and then any sense of uniqueness of particular
money measures as predictably presaging inflation or nominal economic activity pretty much
disappeared to where M1 is now M-anything—the trees, the stock market, the housing.
[Laughter]
MR. SMALL. You were pretty close to Chairman Volcker throughout. You mentioned
his courage and the leap into the unknown. Someone can easily understand the analytics of what
was going on, but what about the personal stress?
MR. AXILROD. I should have felt stress, but I didn’t. It’s weird. I feel stress very
easily. Normally, as a kid, you get a stomach ache, you feel stressed. Or your wife gets slightly
mad at you, and you are thinking she’s madder than she is. That gives you real stress.
[Laughter] But I didn’t feel any. Paul must have, but I couldn’t tell. And we were very close.
Everything I did I told him about. There was a lot of statistical finagling. I don’t mean finagling
in a bad sense, but changes and adaptations as new deposit and bank reserves data became
available on virtually a daily basis. The multipliers change, or the demand for reserves was
changing because more money was demanded by the public, all affecting total reserves. I had to
raise the original nonborrowed reserves path, lower it, or leave it alone depending on the reasons
for and the extent of change. That was a big thing.
If Paul had felt pressures, which I would not doubt, I didn’t notice it. I would go into his
office at the end of the day, but at the early end, because I didn’t want to be stuck there. His wife
was in New York a lot of that time. Many people liked to be stuck, but I didn’t. I would check
in at the end of the day to brief him on occasion or simply to check if he had anything more on
his mind. In the morning after I talked to the manager of the Open Market Account at the New

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York Reserve Bank, I’d talk to Paul, and we’d talk through what the manager was intending to
do. The manager couldn’t do anything unless I called back and said, “Yes, it’s all right.” So we
were in very close contact on these things. Even if Paul was in China, I would get in touch with
him before the manager could do anything. The manager often wondered how much was coming
from me and how much from Volcker. I would always be clear when I was giving an opinion of
mine alone, when I was interpreting how Paul felt, and when I was relaying specific preferences
of the Chairman. I would talk to the manager in advance of his operations. We’d have some
understanding, and he could make a decision in light of how things were evolving. Then I would
tell Paul what the manager was thinking, which might have been something in between what all
of us were thinking. Then if it was okay, it was okay. It was a very closely run system. Paul
was highly involved in it, and his judgment was very good.
Financial Fragility and Crises
MR. SMALL. What about the role of financial fragility and crises?
MR. AXILROD. I was not so involved much with Paul on that. Other people were much
more involved with him on that than I. Ted Truman did a lot, though I forgot exactly what, in
connection with international-related issues.
I remember two things about crises in those early days. One—which makes me angry at
what is going on today—was under Burns. Burns has this bad rap. But he had the foresight to
ask me to organize and figure out what one would do if S&Ls went into a liquidity- or
bankruptcy-threatening crisis. How we would lend, collateral issues, the communication routes
for coordinating decisions, and et cetera. I tried to figure it all out, got memos, got the New
York Fed involved, and worked out who would send the memo to whom to get it done, who
would call whom at what time, how the Board would be kept informed, and when it would need

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to vote. It was a detailed plan for coping with an S&L crisis that might involve lending by the
Fed. It was not a regulatory plan, not one involving actions by regulators that might modify a
crisis; others would have had to work on that if anyone did.
My impression is that detailed contingency planning was not carried out by the U.S.
Treasury, and I am not so sure about the Fed either, even as the potential of a really bad crisis
became increasingly obvious in the spring and summer of 2008. I think that contributed to
making the events in the latter part of 2008 so close to an unmitigated disaster. The Congress
was not presented with a well thought-through plan to consider after the Lehman Brothers
debacle. That contributed to the political difficulties in reaching agreement in the Congress and
to the resulting devastating further drop in the stock market and in public confidence in the
government’s ability to deal with the crisis, all of which, in my opinion, intensified the recession
beyond what need have been. Under Arthur Burns, at least we did do a lot of preplanning for the
prospective savings and loan crisis of that day. I don’t think that crisis really hit, however, until
Paul was Chairman.
There was a threatening crisis at the time of an IMF meeting in Toronto in September
1982, a Mexican debt crisis, I believe, but I forget its particulars. I was going to Toronto. Upon
arrival at the hotel, I was watching a Canadian Football League game. I couldn’t figure why
they had these 12 players to a side. All they did was run around and catch passes. I got a call
from Paul, who was at the U.S. headquarters of the IMF in Toronto. He said, “Get up here right
away.” Mike Bradfield and I were sent back to Washington, D.C., that very day. I think Jerry
Corrigan was in that, too.

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My job in the preplanning was to check everything about the discount window that had to
be done and draft a reassuring statement that the Chairman could issue, saying, in effect, “Don’t
worry. We’ll lend against everything.” There was real preplanning on that.
At another point, there were also some issues related to mutual savings banks in the
Northeast, which Paul was very involved in. There was a mutual savings bank in Cleveland in
some trouble. Also, at that time, the mutual savings banks in New England, I think, had a
practically self-defeating insurance system.
MS. CARTER. There were private insurance systems that were still sticking around.
MR. AXILROD. Yes, that’s right. If you were a good bank and some bad bank had to
be insured, then you came under real strain, because the private insurance systems could call on
you. That was the problem. It risked toppling a whole system. It was a difficult kind of
insurance system that existed in many places. And then, in Cleveland, there was something else,
and I guess because of the discount window, I was involved in all that.
MS. CARTER. There were the Ohio and Maryland thrift problems.
MR. AXILROD. Yes. There was something there, too. Reserve Bank presidents really
couldn’t do anything unless they would check with the Board. That meant, initially, Paul.
[Laughter] So he was very closely involved in all that. I’m not sure about Greenspan. I had the
distinct impression, in LTCM (Long-Term Capital Management), that Greenspan was a reluctant
dragon, but I don’t know how much he knew in advance. But under Paul, the Reserve Banks had
very limited room for any kind of maneuver. I remember we controlled carefully the Continental
Illinois debacle. The Chairman was good at that. Early on, before the Continental Illinois
debacle, was when the loans in the Southwest were going bad because of oil or something
down there.

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MS. CARTER. Is this Penn Square? Is this pre-Penn?
MR. AXILROD. No—well, after, I think. It was under Volcker. I got a call from Mike
Bradfield on a Saturday morning. I’m never called on a weekend. He said, “We’re going to
make loans to some bank in the Southwest.”
MS. CARTER. Penn Square in Oklahoma. That led to Continental.
MR. AXILROD. Yes. In a way, the call had to do with loans to be made to some
relatively small bank. I went, “Huh?” I was totally surprised. My thought was, “Why engage in
moral hazard for a small bank?” I hung up, and the next second Paul was on the phone
explaining the background, I guess. I thought he was explaining something other than
background. But I just interpreted that as a degree of ambivalence, because it was a small bank.
I guess the problem was, loans were being upstreamed to larger banks, and you didn’t want that
to widen the risk. The whole thing could come unraveled too quickly if it was, and overall
market soundness could be threatened. That’s all I had to do with regulation-related issues. It
seems like a lot, now that I think about it. It wasn’t primary in my mind.
MS. CARTER. Do you remember much about Continental Illinois?
MR. AXILROD. I remember quite a bit, because it entailed huge borrowing at the
discount window. At the time, if they were short of funds, many banks would borrow overnight
money in the funds market. It was easy to do and to gauge the cost because the Fed’s target for
the federal funds rate, though not publicly announced in those days, was quickly known
throughout the banking system. Therefore, if there was increased demand for federal funds, the
Fed would go in and do repurchase agreements to provide the reserves needed. So, presumably,
there was no real problem for a large individual bank to borrow sufficient federal funds from the
market to cover an overnight need. This was a very prevalent attitude.

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Banks didn’t think—as nowadays, obviously, everyone thinks—that people wouldn’t
want to lend them money. Continental was a very active borrower in the funds market. That
was how it was making its money. Continental was leveraging.
Then there came to be a run on the bank initiated by a large CD withdrawal [redemption]
of $1 million, I think. And, lo and behold, there being a run, no one wanted to lend to them.
Well, the Fed can provide federal funds through open market operations, but that provides funds
to the market as a whole, not to any individual bank. So Continental Illinois had to come to the
discount window. I don’t remember the precise amount that was built up—something like
$8 billion or so is in my head. Soon the FDIC was involved. After a few years, the bank was
sold to, I believe, a Canadian bank.
The Fed, which was the first lender, took the better assets as collateral, held them for
some years, and gradually collected on them as the debt was paid down. The FDIC was, I
believe, stuck with more of the bad assets and definitely was not pleased. “The Fed gets the
good assets, we get the bad assets”—their thought must have been something like that. Then
came some change in law that is quite complicated and was designed to assure a more balanced
distribution of good and bad collateral in such circumstances. 5
MS. CARTER. About the discount window?
MR. AXILROD. Yes. That was a result of the Continental Illinois situation. The Fed
organized a bunch of big city banks as a group to lend. I think the government also guaranteed
large CDs issued by banks at that time. There was much worry that that would make it too easy
for banks to raise money, but it didn’t. No one wanted to give CDs to Continental anyhow,
because if you’re a treasurer of a company, you want to be sure you can get your money out. If

5

The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA).

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you’re a treasurer of a corporation, you don’t want to go to the CFO and president and say, “We
have money in this bank. The government guaranteed it, I’m getting X percent above the market
for it, but there’s a little glitch. I can’t get it for you tomorrow.” This is not good. So, at the
time, other large banks might have had to pay some premium to attract CDs; for sure, none
wanted to be seen anywhere near the discount window.
MR. SMALL. A lot of the current innovation in Federal Reserve lending is done under
the emergency powers. During your tenure, do you remember cases where the Board thought
about using its emergency powers even if it was turned down?
MR. AXILROD. I don’t remember any of that. I think lending to a Federal Home Loan
Bank might have been broached at one point but never came up formally. And I’m not sure
whether it would require emergency power. Nothing came up about commercial paper and all
such stuff, or individuals, partnerships, and corporations. [Laughter]
A funny thing once came up because the FOMC has limited authority to buy state
municipal debt, short term. When some states and local governments got in trouble, which they
did in one of these crises, they wanted us to buy some of their securities. But we said, “No, we
don’t do backdoor financing.” Now the Fed has opened the side doors, the backdoors, and the
front windows [laughter], but we didn’t have that big a crisis to deal with.
MR. SMALL. Reflecting on Mexico and Latin America, do you have any views on the
use of forbearance or mark-to-market accounting—how that exacerbates problems or how
forbearance was useful?
MR. AXILROD. I have a personal opinion on mark-to-market, but that doesn’t bear too
much on the Fed. Forcing mark-to-market on banks and others at a time of chaos, high
uncertainty, and virtual panic in the market surely exacerbates the situation. There should be

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some leeway until a market calms down and prices are not obviously determined more by panic
than by supply-and-demand fundamentals. I don’t know quite what you would call such pricing.
What is the buzz word today?
MR. SMALL. Fair market value?
MR. AXILROD. Perhaps fair market value, whatever that is. It’s essentially an
insoluble problem. Maybe equations can be used to help determine when price movements on
assets are so far out of line with history, cyclical and trend, as to permit more of a judgment
about fair value. The Federal Reserve itself solves this problem by marking to market only the
foreign exchange holdings but not its government security holdings. Now, that’s not very fair.
[Laughter]
So I don’t have any good, tested answer to that one on mark-to-market. It’s obvious that
financial institutions have to do it, and it’s especially obvious now that also you have to mark-tomarket instruments that are off your balance sheet but are really protected by the name of the
bank or the name of the institution. You have to get the capital of the institution into that. That’s
obvious. I have some negative feelings about what’s going on in mark-to-market now, but I
don’t know how to correct it without a much more intrusive—which maybe there ought to be—
regulatory apparatus. The only way to correct it is for the regulatory apparatus to bless some less
volatile mark-to-market system. That gets pretty intrusive, and I don’t know that they can do it
constructively, given past regulatory history.
MR. SMALL. Didn’t forbearance play a big role in the Mexico and the Latin America
crisis?
MR. AXILROD. Yes, forbearance played a really big role, if I’m correctly interpreting
what you mean, in the Japan crisis for them, because their banks were broke. The Japanese

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regulators didn’t insist that if some guy didn’t pay you interest for an extended time, the bank
had to mark that loan down and make itself even worse off. So the regulators forbore for a long,
long time. The weak Japanese economy of the 1990s wasn’t a recession. It was just plain weak
for a long time. It was not because they didn’t clean out the Augean stables of the banks. It was
because they had built so much plant and equipment by the beginning of the 1990s on zero cost
financing, partly because of easy financing from stocks and convertible bonds that were at
essentially zero costs for corporations. This capacity to produce eventually became unusable and
a costly drag on business, because no one was buying enough of that particular product. That
was the cause of their long economic weakness, not the Augean stables. That’s just my opinion,
of course.
There are other examples of forbearance—not something the United States would want to
indulge in. I’ve done a lot of consulting abroad. In China, where the national banking system is
essentially broke because it makes bad loans to bad industries, they’re walled off. They have got
an ongoing system of encompassing essentially nationalized banks and industries which may or
may not stay stable, so that’s just walled off. No problem—the national budget funds it. And in
Algeria, where there are national banks that are broke, that’s just put on the nation’s budget, and
the banks are subsidized. I forgot what they technically call it, but they just pay it out like we’re
doing, in a sense. Here we’re putting capital in on a one-time basis, but instead you could have
bought the assets if you’d acted soon enough and confidently enough. I have some sympathy
with forbearance, particularly in an overly leveraged situation, because otherwise the collapse
can be so sharp and extreme as to threaten extreme losses of confidence in society and the
political system.

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But forbearance has to have some penalty, somewhere somehow affecting the people and
institutions that are being forborne, if that’s the right word. I don’t know exactly how to do it—it
depends on circumstances—but I would use everything, every weapon you’ve got. But you can’t
use it in a confused, messed up way. I didn’t learn a lot practically from what I went through
about all that, because our crises at the time were much simpler and less existentially threatening.
I remember a funny related story early on in the S&L crisis under Reagan. A young but
quite high Treasury official came to me to discuss how to solve it. He said, “It’s only a paper
problem.” I said, “What?” He said, “Well, if people don’t withdraw their money, there’s no
problem.” I said, “Oh?” I didn’t say, “Do you want to be the last one out?” [Laughter]
So there’s a certain lack of understanding that goes on here and wishful thinking in
certain political quarters. You really have to be ruthless in your thinking.
All I’ve gotten out of all of this is to preplan for the worst. That really ought to be done.
We did that at one point under Arthur Burns in the S&L crisis. Luckily, the crisis didn’t really
arise at the time, partly, as I earlier noted, because we didn’t choose to fight inflation as hard as
perhaps we should have. If you preplan for the worst, the worst thing that could happen is if it
leaks. Then, unfortunately, there will be a run on banks or others involved.
MR. SMALL. Thank you very much for your time.

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