did not increase at all—for the first time since the 1960s, it had been under
a 3 percent annual rate for three years running. Low to stable prices
were becoming a reality and an expectation—so much so that in late 1994,
when I spoke to the Business Council, an association made up of the heads
of major companies, a few of the CEOs were complaining that it was
hard to make price increases stick. I was unsympathetic. "What do you
mean, you're having problems?" I asked. "Profit margins are going up. Stop
complaining."
For decades, analysts had wondered whether the dynamics of the business
cycle ruled out the possibility of a "soft landing" for the economy—a
cyclical slowdown without the job losses and uncertainty of a recession.
The term "soft landing" actually came from the 1970s space race, when the
United States and the Soviet Union were competing to land unmanned
probes on Venus and Mars. Some of those spacecraft made successful soft
landings, but the economy never had; in fact, the expression wasn't even
used at the Fed. But in 1995, a soft landing was exactly what took place.
Economic growth slowed throughout the year, to an annualized rate of less
than 1 percent in the fourth quarter, when our metaphoric spacecraft gently
touched down.
In 1996, the economy picked back up again. By November, when President
Clinton would win reelection, activity was expanding at a solid
4 percent rate. The media celebrated a soft landing long before I was willing
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to; even in December 1996 I was still cautioning colleagues, "We haven't
fully completed the process. Six months from now we could run into a recession."
But in hindsight the soft landing of 1995 was one of the Fed's
proudest accomplishments during my tenure.
All of this lay hidden in the future, of course, as the FOMC was tightening
rates. Knowing when to start tightening, and by how much, and most
important, when to stop was a fascinating and sometimes nerve-racking intellectual
challenge, especially because no one had tried it this way before. It
didn't feel like "Oh, let's execute a soft landing"; it felt more like "Let's jump
out of this sixty-story building and try to land on our feet." The toughest
call for some committee members was the rate hike that proved to be the
last—a 0.5 percent increase on February 1,1995. "I fear that if we act today,
our move may be the one we turn out to regret," said Janet Yellen, a governor
who would later become chairman of Clinton's Council of Economic
Advisors. She was the most vocal advocate for shifting to a stance of wait
and see. The increase, which we went on to adopt unanimously that day,
brought the fed funds rate all the way to 6 percent—double where it had
stood when we'd started less than a year before. Everyone on the FOMC
knew the risks. Had we turned the screw one time too many? Or not
enough? We were groping through a fog. The FOMC has always recognized
that in a tightening cycle, if we stop too soon, inflationary pressures will re-
surge and make it very difficult to contain them again. We therefore always
tend to take out the insurance of an additional fed funds increase, fully expecting
that it may not be necessary. Ending the course of monetary antibiotics
too soon risks the reemergence of the infection of inflation.
F
F
or President Clinton, meanwhile, 1994 had been a miserable year. It
was marked by the collapse of his health care initiative, followed by the
stunning loss of both the House and the Senate in the midterm elections.
The Republicans won on the basis of Newt Gingrich's and Dick Armey's
"Contract with America," an anti-big-government plan that promised tax
cuts, welfare reform, and a balanced budget.
Within weeks Clinton was put to the test again. In late December,
Mexico revealed that it was on the brink of financial collapse. Its problem
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was billions of dollars of short-term debt; borrowed when the economy
was thriving. Lately that growth had slowed, and as the economy weakened,
the peso had to be devalued, making the borrowed dollars increasingly
expensive to repay. By the time Mexico's leaders asked for help,
government finances were in a downward spiral, with $25 billion coming
due in less than a year and only $6 billion in dollar reserves, which were
dwindling fast.
None of us had forgotten the Latin American debt crisis of 1982, when
an $80 billion default by Mexico had triggered a cascade of emergency
refinancings in Brazil, Venezuela, Argentina, and other countries. That
episode nearly toppled several giant U.S. banks, and had set back economic
development in Latin America by a decade. The crisis of late 1994 was
smaller. Yet the risk was hard to overstate. It, too, could spread to other nations,
and because of the growing integration of world financial markets
and trade, it threatened not just Latin America but other parts of the developing
world. What's more, as NAFTA demonstrated, the United States and
Mexico were increasingly interdependent. If Mexico's economy were to
collapse, the flow of immigrants to the United States would redouble and
the economy of the Southwest would be clobbered.
The crisis hit just as Andrea and I were leaving on a post-Christmas
getaway to New York. I'd booked us into the Stanhope, an elegant Fifth
Avenue hotel directly across from Central Park and the Metropolitan Museum
of Art. We'd been looking forward to a few days of concerts, shopping,
and just wandering around in the relative anonymity of the city where
we'd met. Ten years had passed since the snowy evening of our first date for
dinner at Le Perigord on East Fifty-second Street, and while this wasn't a
formal anniversary, we always liked to make it back to the city and the site
of that first date between Christmas and New Year's.
As soon as we arrived, though, the phone began to ring—it was my office
at the Fed. Bob Rubin, now the treasury secretary designee, urgently
needed to talk about the peso. Bob was slated to take over officially from
Lloyd Bentsen, who was retiring, right after New Year's Day, but for all intents
and purposes he was already on the job. I'm sure he'd been hoping for
an easier transition than this. Instead he was facing a baptism by fire.
Andrea realized instantly what the phone call meant. On any foreign
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financial crisis affecting the United States, the Treasury Department takes
the lead but the Fed always gets involved. "So much for romance/' she
sighed. She understood me and my job too well after all these years—I was
grateful for her generosity and patience. So as the Mexico crisis unfolded,
she went shopping and visited friends, and I spent the entire stay in our hotel
room on the phone.
In the following weeks, the administration huddled with Mexican officials,
the International Monetary Fund, and other institutions. The IMF was
prepared to offer Mexico what help it could, but it lacked the funds to
make a decisive difference. Behind the scenes I argued, as did Bob Rubin
and his top deputy, Larry Summers, and others, that U.S. intervention
should be massive and fast. To forestall a collapse, Mexico needed sufficient
funding to persuade investors not to dump pesos or demand immediate
repayment of their loans. This was based on the same principle of market
psychology as piling currency in a bank's window to stop a run on the
bank—something U.S. banks used to do during crises in the nineteenth
century.
In Congress, remarkably, leaders from both parties were in accord; potential
chaos in a nation of eighty million people with whom we shared a
two-thousand-mile border was too serious to ignore. On January 15, President
Clinton; Newt Gingrich, the new House Speaker; and Bob Dole, the
new Senate majority leader, jointly put forward a $40 billion package of
loan guarantees for congressional approval.
As dramatic as that gesture was, within days it became clear that politically
the bailout didn't have a prayer. Americans have always resisted the
idea that a foreign country's money problems can have major consequences
for the United States. Mexico's crisis, coming so soon after NAFTA, aggravated
this isolationist impulse. Everyone who'd fought NAFTA—labor,
consumer, and environmental activists, and the Republican right—rose up
again to oppose the rescue. Gene Sperling, one of Clinton's top economic
advisers, summed up the political dilemma: "How do you deal with a problem
that to the public doesn't seem important, that seems like giving money
away, that seems like bailing out people who made dumb investments?"
When the $40 billion proposal was rolled out, Newt Gingrich asked
me if I would call Rush Limbaugh and explain why it was in America's best
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interest to intervene. "I don't know Rush Limbaugh/' I said. "Do you really
think calling him will make a difference?" "He'll listen to you/' Gingrich
told me. The ultracombative radio host was a force among conservatives.
Some of the freshman congressmen had actually taken to calling themselves
the Dittohead Caucus, using the favorite nickname of fans of his
show. Needless to say Limbaugh was having a field day trashing the thought
of giving Mexico a hand. I was still dubious, but it impressed me that the
new House Speaker was willing to support a Democratic president on a
clearly unpopular issue. So reluctantly I picked up the phone.
Limbaugh seemed even less comfortable than I. He listened politely as
I laid out my arguments, and thanked me for taking the time. This surprised
me—I'd expected Rush Limbaugh to be more confrontational.
The situation couldn't wait for Congress to come around. In late January
with Mexico teetering on the brink, the administration took matters into its
own hands. Bob Rubin turned to a solution that had been proposed and dismissed
early on: tapping an emergency Treasury fund that had been created
under FDR to protect the value of the dollar. Rubin felt great trepidation
about risking tens of billions of taxpayers' dollars. And even though the congressional
leaders promised to acquiesce, there was the risk of appearing to
circumvent the will of the people: a major poll showed voters opposed helping
Mexico by a stunning margin of 79 percent to 18 percent.
I pitched in to help work out the details of the plan. Rubin and Summers
presented it to President Clinton on the night of January 31. The surprise
was still in Bob's voice when he phoned afterward to report the result.
Clinton had said simply, "Look, this is something we have to do," Rubin told
me, adding, "He didn't hesitate at all."
That decision broke the logjam. The International Monetary Fund and
other international bodies more than matched some $20 billion of guarantees
from the Treasury to offer Mexico a package totaling, with all its components,
$50 billion, mostly in the form of short-term loans. These weren't
giveaways, as opponents had claimed; in fact, the terms were so stiff that
Mexico ended up using only a fraction of the credit. The minute that confidence
in the peso was restored, it paid the money back—the United States
actually profited $500 million on the deal.
It was a sweet victory for the new treasury secretary and his team. And
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the experience formed a lasting bond between Rubin; Summers, and me. In
the countless hours we spent analyzing the issues, brainstorming and testing
ideas, meeting with our foreign counterparts, and testifying before Congress,
we became economic foxhole buddies. I felt a mutual trust with
Rubin that only deepened as time passed. It would never enter my mind
that he would do something contrary to what he said he would do without
informing me in advance. I hope it was the same way with him. Even
though we came from opposing parties, there was a sense that we were
working for the same firm. We agreed on many basic issues and neither of
us liked confrontation for confrontation's sake, which made it easy to communicate
and spark off each other's ideas.
Summers, of course, had started as the economics wunderkind.The son
of Ph.D. economists and the nephew of two Nobel laureates in economics,
he was one of the youngest professors ever to get tenure at Harvard. Before
joining the administration, he'd been chief economist of the World Bank.
He was an expert in public finance, development economics, and other
fields. What I liked best was that he was a technician and a conceptualizer
like me, with a passion for grounding theory in empirical fact. He was also
steeped in economic history, which he used as a reality check. He worried,
for example, that the president was getting carried away with the promise
of information technology—as though the United States had never gone
through periods of rapid technological progress before. "Too yippity about
productivity" was how Larry once described Clinton's techno-enthusiasm.
I disagreed, and we had debates about the Internet's potential, with Bob
taking it all in. Larry could be shrewd too: it was his idea to put such a high
interest rate on the Mexico loans that the Mexicans felt compelled to pay
us back early.
Rubin and Summers and I met confidentially over breakfast each week
for the next four and a half years, and we would phone and drop by one
another's offices frequently in between. (Larry and I continued the practice
after Bob returned to Wall Street in mid-1999 and Larry became treasury
secretary.) We'd gather at 8:30 a.m. in Bob's office or mine, have breakfast
brought in, and then sit for an hour or two, pooling information, crunching
