to retire from the company, and I was enthusiastic to learn he was at the
top of the list for treasury secretary. Dick Cheney called to tell me that Paul
had met with President-elect Bush and was feeling torn. "He's got two
pages of pros and cons," Cheney said. "Can you talk to him?"
I was delighted to pick up the phone. Using the same words with Paul
that Arthur Burns had spoken to me in the waning days of the Nixon administration,
I said, "We really need you down here." That argument had
helped persuade me to leave New York and go to work in government for
the first time, and it worked on Paul too. I thought his presence would be
an important plus for the new administration. Would the president's programs
and budgets foster the American economy's long-term prospects?
What would be the caliber of his economic advisers and staff? On those
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counts, it seemed to me that making Paul the man who signed the dollar
bills was a major step in the right direction.
There was another consideration, partly professional and partly personal.
President Clinton had reappointed me early in 2000, so I had before
me at least three more years as chairman. The Fed and the Treasury Department
had made great music together throughout most of the 1990s.
(Granted, there had been the occasional discord over turf.) We'd managed
economic policy through the longest boom in modern U.S. history, improvised
effectively in times of crisis, and helped the White House work down
the horrendous federal deficits of the 1980s. My collaboration with Clinton's
three treasury secretaries, Lloyd Bentsen, Bob Rubin, and Larry Summers,
had contributed to that success, and we considered one another
friends for life. I wanted to build an equally fruitful dynamic with the incoming
administration—for both the Fed's sake and my own. So I was gratified
when Paul finally said yes.
The most important returning Ford veteran, of course, was the vice
president-elect. Dick Cheney had succeeded Rumsfeld, his mentor, as
White House chief of staff, becoming at age thirty-four the youngest person
ever to hold that post. With his combination of intensity and sometimes
sphinxlike calm, he'd shown extraordinary skill in the job. The
camaraderie we built in those years following Watergate had not waned. I
would see him at Ford reunions and at other gatherings during his years as
a congressman, and I was delighted when the first President Bush appointed
him secretary of defense in 1989. There is little overlap between the duties
of the secretary of defense and the chairman of the Federal Reserve, yet
we'd kept in touch.
So now he was vice president-elect. I knew that many commentators
believed he would be much more than vice president; because Cheney was
so much more experienced in national and global affairs than George W.
Bush, they thought he would become de facto head of government. I did
not believe that—from my brief acquaintance with the president-elect, it
was my impression that he was his own man.
In the weeks following the election, Cheney sought my input, as I'm
sure he sought the input of other old friends. He and his wife, Lynne, hadn't
yet moved to the vice presidential residence at the Naval Observatory, so
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on Sunday afternoons I'd drive to their home in the Washington suburb of
McLean, Virginia, where he and I would sit at the kitchen table or settle
down in the den.
The tone of our friendship shifted with his new position: I no longer
called him Dick, but rather "Mr. Vice President," and while he hadn't asked
for this new formality, he acquiesced. Our talks were mainly about the
challenges facing the United States. Often we went into very specific detail.
A key topic was energy. The recent oil-price spike had been a reminder that
even in the twenty-first century, supplies of basic industrial-age resources
remained a major strategic concern. Indeed, Cheney's first major focus in
office was to convene a task force on energy policy. So I gave him my
analysis of oil's role in the economy and of how the international oil and
natural gas markets were evolving; we discussed nuclear power, liquefied
natural gas, and other alternatives.
The greatest economic challenge on the domestic front, I argued, was
the aging of thirty million baby boomers. Their retirement was no longer
on the distant horizon, the way it had been when I'd become involved in Social
Security reform under Reagan. The oldest boomers were set to turn
sixty in six years, and the financial demands on the system would become
extremely heavy in the decades beginning in 2010. Social Security and
Medicare would need major revision to stay solvent and effective over that
long term.
Dick made it clear that domestic economic policy was not going to be
his bailiwick. All the same, he was curious about my ideas; he listened
closely and often took notes that I assumed he might pass along.
During those last days of December and first days of January, I indulged
in a bit of fantasy, envisioning this as the government that might
have existed had Gerald Ford garnered the extra 1 percent of the vote he'd
needed to edge past Jimmy Carter into a second term. What was more, for
the first time since 1952, the Republican Party had ended up with not just
the White House but both houses of Congress. (The Senate was actually
split 50-50 between Republicans and Democrats, but as Senate president,
Cheney would hold the tie-breaking vote.) I thought we had a golden opportunity
to advance the ideals of effective, fiscally conservative government
and free markets. Reagan had brought conservatism back to the White
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House in 1980; Newt Gingrich had brought it back to Congress in 1994.
But no one had put it together the way this new administration now had a
chance to do.
I looked forward to at least four years of working collegially with many
of government's best and brightest, men with whom I had shared many
memorable experiences. And on a personal basis, that is how it worked out.
But on policy matters, I was soon to see my old friends veer off in unexpected
directions. People's ideas—and sometimes their ideals—change over
the years. I was a different person than I had been when first exposed to the
glitter of the White House a quarter of a century before. So were my old
friends: not in personality or character, but in opinions about how the world
works and, therefore, what is important.
I
I
n the weeks before the inauguration, the FOMC was scrambling to make
sense of a complicated picture: the sudden slowdown of our $10-trilliona-
year economy and the practical implications for the Fed of the huge
ongoing government surpluses. When the FOMC convened the day after
my meeting with the president-elect, the downturn was at the top of the
agenda.
Recessions are tricky to forecast because they are driven in part by
nonrational behavior. Sentiment about the economic outlook usually does
not shift smoothly from optimism to neutrality to gloom; it's like the bursting
of a dam, in which a flood backs up until cracks appear and the dam is
breached. The resulting torrent carries with it whatever shreds of confidence
there were, and what remains is fear. We seemed to be confronting
just such a breach. As Bob McTeer, the head of the Federal Reserve Bank of
Dallas, put it: "The R word is now used openly just about everywhere."
We decided that unless conditions improved over the next two or three
weeks, interest rates would have to come down. For now, our position
would be simply to express concern. As our public statement put it:
"The Committee will continue to monitor closely the evolving economic
situation... .The risks are weighted mainly toward conditions that may
generate economic weakness in the foreseeable future." Or as one committee
member wryly translated, "We are not yet panicking."
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Within two weeks, it was plain that the downtrend was not leveling off.
On January 3, the first business day of the New Year, we convened again via
conference call and cut the fed funds rate by half a percentage point, to
6 percent. The media took this move as a surprise, even though we'd hinted
at it before Christmas, but that was fine: the Fed was responding to the
markets and the economy.
In fact, we thought that this cut might be the first of many that would
be necessary to stabilize the economy. I told the committee that it seemed
to me any subsequent cuts might have to be made more quickly than usual.
The same technology that was boosting productivity growth also might be
speeding up the process of cyclical adjustment. A just-in-time economy
demanded just-in-time monetary policy. Indeed, that would become our
rationale as we cut the fed funds rate by another half percentage point before
January was out, and again in March, April, May, and June, bringing it
all the way down to 3.75 percent.
The other issue looming large for the FOMC was the disappearance of
the national debt. Strange as it may seem in hindsight, in January 2001 the
possibility was real. Nearly a decade of rising productivity growth and budget
discipline had put the U.S. government in a position to generate surpluses
"as far as the eye could see," to borrow the phrase coined by President
Reagan's budget director David Stockman in projecting deficits nearly two
decades earlier. Even allowing for the recession that might now be setting
in, the nonpartisan Congressional Budget Office was getting ready to raise
its projection of the surplus to a stunning $5.6 trillion over ten years. This
was $3 trillion higher than the CBO had forecast in 1999, and $1 trillion
more than it had predicted just the previous July.
I'd always had doubts that budget surpluses could persist. Given the
inherent tendency of politicians to err on the side of spending, I found it
difficult to imagine Congress ever accumulating anything but deficits. My
skepticism that surpluses were here to stay had been why, a year and a half
before, I'd urged Congress to hold off on the nearly $800 billion ten-year
tax cut that President Clinton ultimately vetoed.
Yet I had to acknowledge that the general consensus among economists
and statisticians I respected—not just at the CBO but also at the Office of
Management and Budget, at the Treasury, and at the Fed—was that under
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current policy, surpluses would continue to build. It seemed that the surge
in productivity growth unleashed by the technology revolution was upsetting
the old assumptions. As the evidence for this ongoing surplus mounted,
I felt an odd sense of loss. The economic model I carried around in my head
seemed obsolete. Congress was in fact not spending money faster than the
Treasury was taking it in. Had human nature changed? For months Fd been
wrestling with the idea that it might be possible—it was a question of do
you believe your crazy old theories or your lying eyes?
My colleagues at the FOMC seemed a bit disoriented too. In our late-
January meeting, we spent hours trying to imagine how the Fed would operate
in a brave new world of minimal federal debt. Of course, shedding the
debt burden would be a happy development for our country but it would
nevertheless pose a big dilemma for the Fed. Our primary lever of monetary
policy was buying and selling treasury securities—Uncle Sam's IOUs.
But as the debt was paid down, those securities would grow scarce, leaving
the Fed in need of a new set of assets to effect monetary policy. For nearly
a year, senior Fed economists and traders had been exploring the issue of
what other assets we might buy and sell.
A result was a dense 380-page study that plopped on our desks in January.
The good news was that we weren't going out of business; the bad news
was that nothing could really match the treasuries market in size, liquidity,
and freedom from risk. To conduct monetary policy, the report concluded,
the Fed would have to learn to manage a complex portfolio of municipal
bonds, bonds issued by foreign governments, mortgage-backed securities,
auctioned discount-window credits, and other debt instruments. It was a
daunting prospect. "I feel kind of like Alice in Wonderland," Cathy Minehan,
the president of the Federal Reserve Bank of Boston, had said when
the issue first came up, and we all knew what she meant. The very fact of
the discussion showed how profoundly and rapidly we thought the economic
landscape might change.
T
T
he surplus was also what had Paul O'Neill and me excited as we met
during January to swap budget ideas. We both knew, of course, that
the CBO's figure of $5.6 trillion over ten years needed to be unpacked.
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About $3.1 trillion would be untouchable money—reserved for Social Security
and Medicare. That left a prospective $2.5 trillion in usable funds. A
major tax cut; of course, had been the centerpiece of George Bush's presidential
campaign. He'd set himself apart from his father by vowing early
on, "This is not only 'No new taxes.' This is 'Tax cuts, so help me God."
Cutting taxes was the highest, best use of the surplus, Bush asserted, rejecting
Al Gore's position that equally important priorities should be to pay
down debt and create social programs. As Bush put it in the first debate:
"My opponent thinks the surplus is the government's money. That's not
what I think. I think it's the hardworking people of America's money." Taking
a page out of Reagan's book, he was proposing a sweeping $1.6 trillion
cut, phased in over ten years across all tax brackets. Gore had campaigned
