The Long Boom of the 1990s

CEA Chair Charles Schultze: We cannot fine tune the economy, and we do not intend to try.

Congressman Henry Reuss: Well, I think you have got to fine tune the economy, and you should intend to try.


The 1990s are known, macroeconomically, for the long boom that stretched from 1991 all the way into 2001. But the decade didn’t start out smoothly. According to National Bureau of Economic Research (NBER) dating, a brief and mild recession began in July 1990 and ended in March 1991. During that time span, real GDP fell for only two quarters (1990:4 and 1991:1) and by a total of only 1.4 percent. Then when the recession ended, the nation embarked on an unbroken expansion that was destined to last ten years. At the time, it was the longest expansion in U.S. history by far. (The 2009–2020 expansion would later eclipse that record.) This happy episode is often referred to as “the Clinton boom” because Bill Clinton was president for eight of those ten years.

The Bush Recession?

In fairness, however, it all began under President George H. W. Bush. Ironically, the words “fairness,” “Bush,” and “business cycle” do not join together easily because the business cycle was patently unfair to the first President Bush. As discussed in chapter 9, the 1990–1991 recession is more accurately blamed on Saddam Hussein and the brief but sharp oil shock he engendered by invading Kuwait in August 1990. It certainly cannot be attributed to the tax hike to which Bush reluctantly agreed in November 1990 but which went into effect only in January 1991. By that time, the recession was almost over.

Nonetheless, Bill Clinton and the Democrats hammered the incumbent president on the weak economy during the 1992 campaign even though the growth rate of real GDP over the first three quarters of 1992 averaged a robust 4.5 percent. Voters, however, didn’t understand that when they went to the polls in November 1992—perceptions lag behind realities. For example, as late as September 1992, some 80 percent of respondents told a Gallup poll that they thought the economy was in decline (CNN/Knight Ridder 1992).

What went wrong for Bush? Quite a lot. Part of the story was political. He gained the enmity of many members of his own party when he agreed to raise taxes after pledging not to do so. As the New York Times reported at the time, “A civil war broke out among Republicans today as dozens of House members insisted that White House lobbying would not stop them from seeking to thwart the budget package.” One of the leading warriors was Newt Gingrich (R-GA), who would go on to become Speaker of the House when Republicans gained control in January 1995. According to Gingrich, the Andrews agreement “will kill jobs, weaken the economy” and “the tax increase will be counterproductive” (Berke 1990).

In addition, the nation normally grows weary of one-party rule after twelve years or even eight. In this case it was Republican rule, and three “Reagan terms” were probably enough for the electorate. Finally, the young governor of Arkansas proved to be a formidable campaigner, a remarkably intuitive politician, and a debater who could “feel your pain” in a way the patrician Bush could not. One famous incident encapsulated this difference poignantly. During an October 1992 debate in town hall format, the TV camera caught Bush looking longingly at this watch—seeming to hope the ordeal would soon be over—while Clinton, oozing sympathy, waded into the crowd enthusiastically.

FIGURE 11.1. Payroll employment, monthly, January 1990–December 1992.

Source: Bureau of Labor Statistics.

Other parts of Bush’s electoral problem were macroeconomic, however. The recovery from the 1990–1991 recession was “jobless” at first. The national unemployment rate, which had hovered in the neighborhood of 5.5 percent from Bush’s January 1989 inauguration through the NBER business cycle peak in July 1990, rose to 6.8 percent in March 1991, the month of the NBER trough. That’s not a huge increase. But then unemployment kept climbing during the “recovery,” hitting a high of 7.8 percent in June 1992. In the election month, it was still 7.4 percent. To many Americans, it didn’t feel like a recovery at all.

Job growth was sluggish throughout the period, as figure 11.1 shows. About 1.6 million jobs disappeared during the recession. Then they came back at a snail’s pace during the early stages of the recovery, averaging essentially zero net new jobs per month until early 1992 and then just 56,000 per month over the eighteen months from June 1991 through November 1992. This behavior of employment differed from historic norms only in degree, not in kind. It is normal for the decline in the unemployment rate to lag behind the recovery in GDP. As luck would have it—bad luck for George Bush, good luck for Bill Clinton—the pace of job creation accelerated smartly right after the election, to 226,000 jobs per month over the next twelve months. The unkindness of the business cycle was one big reason why Clinton defeated Bush handily in the 1992 election.

A White House at War with the Fed

Bush blamed his electoral defeat on Alan Greenspan’s monetary policy, which Bush himself, his treasury secretary, his Council of Economic Advisers (CEA) chair, and other administration figures claimed was too tight.1 This blaming, in fact, started well before the recession. Richard Darman, the brilliant but abrasive Baker protégé who was Bush’s budget director, took the lead in attacking the Fed. In a September 1989 appearance on Meet the Press (note the early date), he opined that the Fed “may have been a little too tight” and suggested that “if we do have a recession,” it would be the Fed’s fault (Woodward 2000, 62). Greenspan was watching on TV that morning, and as he put it, “I nearly spilled my coffee.… Listening to his argument, I thought it made no economic sense.… [I]t was political rhetoric” (Greenspan 2007, 119). Darman didn’t relent, however. He subsequently peppered Greenspan with memos and faxes, none of which endeared the brash budget director to the reserved Fed chair. When the recession finally did arrive, Darman blamed Greenspan (Woodward 2000, 89).

Secretary of the Treasury Nicholas Brady, a Bush chum from Yale days, followed Darman in urging Greenspan to cut interest rates more aggressively. Brady did so both privately and in the media. After hearing his fill of this, an exasperated Greenspan at one point challenged Brady to call members of the Federal Open Market Committee (FOMC) on the phone and see if he could persuade them. (Brady in fact called a few FOMC members, to no avail [Woodward 2000, 90].) By March 1992, things had gotten so testy that Brady cancelled his weekly breakfast meetings with Greenspan. After that, in the Fed chair’s words, “The ‘Greenspan account,’ as they called it in the White House, shifted to CEA Chair Mike Boskin and the president himself” (Greenspan 2007, 121).

Bush was his usual cordial self, and Greenspan felt that the president of the United States was entitled to an explanation of the central bank’s decisions. But by a June 1992 interview with the New York Times, Bush was saying that “I’d like to see another lowering of interest rates” (Woodward 2000, 91). He had a point. But with the election just months away, the usual lags in monetary policy meant that June 1992 was already too late politically. A looser monetary policy earlier would presumably have led to faster growth in 1992, which would have helped the incumbent president’s reelection bid. There are at least three important “buts,” however.

First, the major macroeconomic problem of 1992 was not laggard GDP growth. As just noted, real GDP grew nicely. The problem was that even robust growth in output did not produce many new jobs—for reasons that are still not well understood. But monetary policy influences the growth rate of GDP, not the way GDP growth translates into jobs. Had Brady somehow convinced Greenspan that the Fed should boost the number of jobs per billion dollars of GDP, it’s unclear what Greenspan and his colleagues could have done to make that happen.

Second, there is really no case that Greenspan was playing politics with the economy in 1990–1992. Without a doubt, this longtime—and highly political—Republican Fed chair favored Bush over Clinton, a Democrat who was far from certain to reappoint Greenspan to a new term in 1996. Yet by all appearances, the Fed chief played it straight. From early 1988 until the spring of 1989, the FOMC raised the federal funds rate by about 300 basis points because it was worried about an overheating economy (figure 11.2). Then it eased as the economy slowed, cutting rates well before the recession began and then cutting them more during the recession and still more after the recession had ended. In total, the FOMC cut the funds rate by almost 700 basis points between April 1989 and the November 1992 election, the last few cuts being aimed squarely at the “jobless recovery.” That sure didn’t look like tight money to tilt the election away from Bush.

FIGURE 11.2. Target federal funds rate, 1988–1992.

Source: Board of Governors of the Federal Reserve System.

Finally, if you are grading the central bank’s performance, it should be remembered that as mentioned in chapter 9, the Greenspan Fed came close to achieving a perfect soft landing in 1989–1990. Indeed, it might have achieved that elusive goal had Saddam Hussein not thrown a monkey wrench into the operation. Thus, in a sense both Bush and Greenspan were victims of the Persian Gulf War but with an important difference: only Bush had to stand for reelection.

The Budget Battle of 1993

Bill Clinton assumed the presidency in January 1993, and his initial budget submission about four weeks later kicked off an epic political battle that lasted six months. Putatively, the Democrats controlled the White House and both Houses of Congress at the time. The door to passing legislation thus seemed wide open, and Clinton had come to Washington with a long agenda. But the Democrats are a famously fractious bunch, prone to forming circular firing squads. As Will Rogers had astutely observed almost sixty years earlier, “I am not a member of any organized party—I’m a Democrat” (O’Brien 1935, 162). Apparently, nothing much had changed in the interim. Congressional Democrats were not about to defer to the young newcomer from Arkansas.

Though much beloved by the financial markets and by many economists, Clinton’s 1993 budget did several things that looked “wrong” from a political perspective. Most hateful to Republicans, it raised income tax rates on upper-bracket taxpayers from the 31 percent top rate established under George H. W. Bush all the way up to 39.6 percent. Never mind that the top tax rate under Dwight Eisenhower had been as high as 92 percent. To the post-Reagan Republican Party, raising marginal tax rates was a mortal sin, as Bush had learned the hard way. Many Republicans bravely or foolishly (take your pick) predicted a recession if taxes were raised.

They also bridled against several of Clinton’s proposed spending programs, the things he liked to call “investments.” For example, Gingrich declared on February 2, 1993 (less than two weeks into the Clinton administration), that “we have all too many people in the Democratic administration who are talking about bigger Government, bigger bureaucracy, more programs, and higher taxes. I believe that that will in fact kill the current recovery and put us back in a recession” (U.S. Congress 1993, 1642).

On the Democratic side of the aisle, most members were less concerned about the income tax hikes but quickly rallied against Clinton’s proposed BTU tax. The idea was first eviscerated with numerous exceptions (What? Make aluminum more expensive? Or coal? Or fertilizer?) and eventually whittled down to a puny 4.3 cents per gallon increase in the federal gasoline tax. Even Clinton’s “investments” got a decidedly mixed reception from Democrats on the Hill. The politics of cutting back old programs to make room for new ones ran into a classic political roadblock: old programs have all sorts of entrenched interests and lobbyists lined up to protect them; new programs do not. On top of all that, some Democrats in Congress were true deficit hawks who insisted on even more deficit reduction than Clinton had proposed. That attitude left little room for new programs.

When the 103rd Congress opened for business in January 1993, the Democrats held seemingly comfortable majorities of 57–43 in the Senate and 258–176 in the House. That looked good on paper, but a naive body count failed to reckon with both the need for sixty votes in the Senate on most bills (though not on the budget) and the lack of discipline in Will Rogers’s old party. As the budget debate dragged on, with Republicans just saying no to everything and Democrats asking the White House for one change after another, a kind of bazaar developed within the Democratic caucuses of both Houses. Member after member refused to promise their votes unless they got X. Different members, of course, had different choices of X. And quite a few seemed willing to hold the whole budget hostage to their own pet idea.

In the end, the Clinton budget barely squeaked through the House. As freshman member Marjorie Margolies-Mezvinsky (D-PA), who had won her seat in a traditionally Republican district, strode down the aisle to make the vote 218–216 in favor, Republicans jeered her with the chant “Goodbye, Marjorie!” And she was in fact defeated in the 1994 election. Over in the Senate, it took a full-court press to convince the maverick senator Bob Kerrey (D-NE) to cast the fiftieth vote for passage, thus enabling Vice President Al Gore to register the tie-breaking vote. Remember, there were fifty-seven Democratic senators at the time. For all his political skills, Clinton managed to get just fifty of them to vote with him. In sum, reducing the deficit in 1993 was extremely popular in principle but far less so in practice.

The new president signed the Omnibus Budget Reconciliation Act of 1993 into law on August 10, 1993. As macroeconomic events unfolded, it turned out to be the fiscal “contraction” that was not contractionary. Instead, the economy boomed. However, nobody knew that in August 1993 even though a strong bond market rally was already under way. All eyes on Clinton’s economic team then turned toward the Fed. Would Greenspan help bail out the fledgling administration with interest rate cuts or at least with interest rate forbearance?

The White House–Federal Reserve Wars End

It is important to remember that when Clinton assumed the presidency in January 1993, there was a widespread feeling in the American populace that the economy had underperformed of late and that only three things mattered: jobs, jobs, and jobs. Indeed, that became the mantra of the new administration. Every policy was evaluated by its potential to create (or, God forbid, to destroy) jobs. I recall a hilarious cartoon that appeared in the New Yorker at the time. It showed Christopher Columbus importuning King Ferdinand and Queen Isabella to fund his voyage with a promise that it “will not only forge a new route to the spices of the East but also create over three thousand new jobs.” While this book is not about trade policy, it is also worth remembering that former presidential candidate Ross Perot railed against the North American Free Trade Agreement on the grounds that there would be “a giant sucking sound” as American jobs moved south of the border.

By contrast with the salience of jobs, most voters paid no attention whatsoever to the Federal Reserve, much less understood its role. When I joined the Federal Reserve Board as its vice chair in June 1994, one of the incumbent governors joked to me that most Americans thought the Federal Reserve was a national forest! Yes, Smokey Bear was more famous than Alan Greenspan, who had not yet been anointed the national guru on all things economic.

Close observers of the Fed such as Clinton and his advisers were, of course, familiar with the charge that stingy monetary policy had cost Bush the election in 1992. And they did not want a repeat performance. Mindful of James Carville’s famous election motto “The economy, stupid,” Team Clinton watched Greenspan carefully and warily.

The back-channel discussions of deficit-reduction targets between the Fed chair and the incoming treasury secretary, Lloyd Bentsen, were discussed in the previous chapter. Greenspan smiled benignly at the deficit-reducing initiatives that Clinton would soon release but made no commitment to cut interest rates as a reward, just as he had made no such commitment to Bush in 1990.

Most of the Clinton economic team and, I believe, Clinton himself saw themselves as at the mercy of the Fed and the bond market. The team’s acknowledged leader, Robert Rubin, had come from a successful bond trading house (Goldman Sachs) and repeatedly observed that bond market reactions were the crucial element. After all, with the federal funds rate already very low—roughly zero in real terms—the FOMC seemed unlikely to cut interest rates much if at all. It was going to be up to the bond market—which, as noted earlier, came through mightily—to prevent deficit reduction from being contractionary.

Unlike Bush and many presidents before him, Clinton understood, absorbed, and accepted something his economic team was telling him: that going to war with the Fed was a risky business, probably a loser’s game. Better to seek a pax Washingtoniana. To that end, Clinton artfully invited Greenspan to sit in a front-row seat in the House gallery for the dramatic February 17, 1993, address to a joint session of Congress that introduced his economic plan. Seating Greenspan between First Lady Hillary Clinton and Second Lady Tipper Gore made for a great camera shot, which was viewed by millions on national TV. To many financial market players, it signaled that Greenspan was endorsing the Clinton budget plan. Right or wrong, that thought pleased Clinton.

Greenspan said later that he was “uncomfortable” with being “positioned up front for a political purpose.” He had expected to be a backbencher (Greenspan 2007, 142). I wonder about that assertion, given Greenspan’s astute political antennae and his well-known penchant for being at the center of things. (He rarely missed an A-list Washington party.) But regardless, after years of warfare with the Bush administration, a noteworthy truce had broken out between the White House and the Fed. This was important for both monetary policy and fiscal policy.

Less than a year later, that truce almost fell apart. Clinton had battled his big deficit-reduction package through Congress, finally getting it passed in August 1993 after many changes, numerous compromises, and considerable political bloodletting. The president correctly viewed that victory as a signal achievement both politically and economically. He breathed a sigh of relief when he saw the bond market smiling at his handiwork by driving down long-term interest rates. But then on February 4, 1994, the FOMC voted to raise interest rates for the first time in five years. The rate hike was just 25 basis points, but it took markets by surprise, bond yields leaped upward, and the stock market fell by about 2.5 percent in a matter of hours. Within a few months as the Fed kept raising rates, the thirty-year Treasury yield was up about 120 basis point from its February 4 level.

We later learned that Greenspan had held back a more hawkish FOMC that wanted to raise rates even more that day. After listening to a majority of the committee express a preference for going up by 50 basis points, not 25, he interjected, “Well, I’ve been around a long time watching markets behave and I will tell you that if we do 50 basis points today, we have a very high probability of cracking these markets.… To go more than 25 at this point I think would be a bad mistake” (FOMC 1994b, 53). Later in the meeting, in a most unusual step, the Fed chair called for the FOMC equivalent of a whipped vote: “I would request that, if we can, we act unanimously. It is a very potent message out in the various communities with which we deal if we stand together. If we are going to get a split in the vote, I think it will create a problem for us, and I don’t know how it will play out” (57). After this plea, the FOMC voted unanimously for 25 basis points.

Because this was the Fed’s first rate hike in five years, Greenspan also took the unprecedented (at the time) step of issuing a press statement, under his own name, explaining that “the decision was taken to move toward a less accommodative stance in monetary policy in order to sustain and enhance the economic expansion” (FOMC 1994a). Yes, you read that right. Greenspan declared that the Fed was tightening monetary policy in order to enhance growth! It was Fedspeak extraordinaire, and that sentiment continued in subsequent statements.

But the most remarkable aspect of that February 4 statement was that it existed at all. Prior to that day and even after, Greenspan was known for being tight-lipped and inscrutable, much like Paul Volcker before him. The Fed’s unspoken motto seemed to be “say very little, and say it cryptically.” Although Greenspan may not have realized it at the time, that first short statement would prove to be the proverbial camel’s nose under what would prove to be a large Federal Reserve transparency tent. But that development was years in the future.

At the White House, Clinton viewed the rate hike of 25 basis points as neither progrowth nor a friendly gesture. He was livid, but only in private. Insiders at the time (I was still one of them) witnessed his anger; he literally turned red. In the president’s view, he had done exactly what Greenspan wanted right down to the deficit reduction number ($140 billion) and at considerable political peril. Yet here was the Fed stabbing him in the back.

His economic team, led by Rubin, managed to talk Clinton down from his anger using two main arguments. The argument that failed was straight economics. We pointed out that the real federal funds rate had been zero for almost a year and a half, which was an unsustainably low level. So, it was not so terrible if interest rates rose a bit; indeed, it was inevitable.

The argument that succeeded came more from the realm of political economy: if the president berated the Fed in public, his rhetoric might get the central bank’s back up and induce it to demonstrate its independence by raising rates even further, as it had perhaps done under President Bush. Furthermore, renewing the war between the White House and the Fed would spook the markets. Bond and stock traders preferred peace; if war broke out instead, stock prices would probably fall, and interest rates would probably rise. Clinton bought into that argument. Most important, he smartly kept his displeasure with the Fed hidden within the White House walls.

The radio silence was deafening. Markets heard virtually nothing from the administration about the Fed other than Rubin’s oft-repeated phrase “We don’t comment on the Fed.” All of us on the Clinton economic team learned to repeat this new mantra in our sleep, especially when talking to the press. The wording was critical. If we praised the Fed after some decisions but not others, those latter cases would be read as veiled criticisms. So, it was always “we don’t comment on the Fed.” And we didn’t.2 After the contentious Bush years, Greenspan must have been thrilled beyond belief.

Robert E. Rubin (1938—)

Successful on Wall Street and in Washington

There is a moderately deep tradition of highly successful Wall Street executives coming to Washington only to fail as secretary of the treasury. The two jobs require different skills and radically different mindsets. But a few succeed, and Robert Rubin was certainly one of them. There is no doubt that he had enormous influence on the thinking of President Bill Clinton. And when Rubin left office in 1999, he was being compared to Alexander Hamilton. Quite a compliment.

Rubin was born in New York City in 1938 but raised mostly in Miami Beach, Florida. From there it was on to Harvard, from which he graduated summa cum laude in economics, and then Yale Law School. Fresh with his law degree in hand, he joined a top New York law firm in 1964 but did not stay there long. Wall Street beckoned, and in 1966 he joined Goldman Sachs. From there it was off to the races. Rubin later ran Goldman’s stock and bond trading departments and became cochair (with Stephen Friedman) in 1990.

While at Goldman, Rubin became heavily involved in Democratic politics and especially in the 1992 campaign of Governor Bill Clinton of Arkansas. Once Clinton was elected to the presidency, Rubin was a natural choice to become the first director of the National Economic Council—a Clinton creation—and thereby the tacit leader of the economic team. In that position, Rubin urged Clinton to reduce the deficit and then helped shepherd the resulting reconciliation bill through Congress.

When Lloyd Bentsen left the Treasury post in January 1995, Rubin was again the natural choice to become secretary of the treasury. Within a few months he was leading something almost unprecedented: a concerted international effort to prop up the sagging dollar via both rhetoric and intervention in the foreign exchange markets. “A strong dollar is in the national interest,” he insisted. The effort to boost the dollar succeeded mightily, earning Rubin the nickname “Trader Bob.” He also worked with the International Monetary Fund and others to ameliorate financial crises in Mexico, other Latin American countries, Russia, and Southeast Asia.

Rubin has been credited with much of the economic success of the Clinton administration, though some of that success was due to Alan Greenspan at the Fed. The biggest blemish on Rubin’s sterling record may well have been his refusal to permit regulation of derivatives—again in partnership with Greenspan.

The broad public, of course, did not realize how unusual the “no comment” policy was. As we have seen in earlier chapters, Presidents John Kennedy, Lyndon Johnson, Richard Nixon, Ronald Reagan, and George H. W. Bush all had either tried to “coordinate” the Fed’s monetary policy with their fiscal policy or berated the Fed for not going along. Clinton changed that—dramatically. This newfound respect for the Fed’s independence would last until Donald Trump became president.

The Perfect Soft Landing

The FOMC continued to raise interest rates as the economy grew: 25 basis points each in March and April 1994, 50 in May, and then after a short pause another 50 in August.3 In the press release following the August 16, 1994, meeting, the FOMC stated that its latest hike of 50 basis points was “expected to be sufficient, at least for a time, to meet the objective of sustained, noninflationary growth.” The phrase “at least for a time” may sound innocuous, but it was a very big deal at the tight-lipped FOMC at the time. It was the first time the committee had ever given what we now call (and routinely expect as) “forward guidance.” By breaking a long-standing taboo, those five words raised eyebrows in the financial markets.4 Speculation about how long “for a time” was began immediately.

It turned out to be about three months. In November, with (unfounded) inflation fears running rampant, the Fed boosted the funds rate by another 75 basis points, the largest change in the entire Greenspan era. Then the FOMC finished the 1994–1995 tightening cycle with another 50 basis points in February 1995. That last rate hike came during Mexico’s financial crisis, a fact that did not faze the FOMC. Neither did the concerned voices of Janet Yellen (then a Fed governor) and me (I was vice chair), who worried that the Fed might be overdoing it. Neither of us registered a formal dissent, however. Lodging a dissent poses a high bar for a member of the Federal Reserve Board and an even higher bar for its vice chair. (In fact, no vice chair has ever dissented.) We didn’t feel that our disagreement with Greenspan warranted jumping that high.

As the Fed raised the funds rate in increments, long rates backed up, starting with a flurry of activity (and volatility) at the first rate hike. By May 1994, the thirty-year Treasury yield (the benchmark at the time) was all the way back to where it had been on election day 1992, and it then kept rising through the Fed’s notable rate hike of 75 basis point in November. By that time, market expectations of how high the FOMC would go were clearly exaggerated relative to expectations held inside the committee.5 That exaggerated view didn’t do any good to bond prices.

By the time the dust settled on the Fed’s rate-hiking cycle, the federal funds rate had been raised from 3 percent to 6 percent in a year’s time. With the inflation rate virtually unchanged over that period, the real federal funds rate had also gone up about 300 basis points, from about zero to about 3 percent. At that point, Greenspan and the FOMC stopped. The thirty-year bond rate, incidentally, rose by about 150 basis points on net over this period.

In getting to the 6 percent funds rate, the committee had agonized over each rate hike as well as several decisions to stand pat. At meeting after meeting, it was “Shall we do 50 basis points, 25, or zero today?” If that’s not fine-tuning, I don’t know what is. And it worked—perfectly. When the tightening cycle ended in February 1995, the unemployment rate was down to 5.4 percent, which was close to contemporary estimates of the natural rate, and the Consumer Price Index inflation rate (over the preceding twelve months) was 2.9 percent. Greenspan and the Fed would probably have been content to live with numbers like those forever, and they almost did.

When the economy weakened in 1995 to a sluggish 1.3 percent growth rate in the first half of the year, there was more fine-tuning. The FOMC inched the funds rate down to 5.25 percent in three baby steps of 25 basis points each, ending in January 1996. Then the FOMC held the rate there for more than a year except for one little increase of 25 basis points in March 1997. The funds rate was thus sitting at 5.5 percent when the financial crisis struck in August 1998, precipitated by the dramatic collapse of the famous hedge fund Long-Term Capital Management and by Russia’s stunning choice to default on its sovereign debt.

The Fed responded to the financial chaos that emerged by cutting the federal funds rate 25 basis points on September 29, 1998. Notably, that dramatic emergency action was not taken because the U.S. economy needed a boost; real GDP growth over the first three quarters of 1998 averaged a robust 4.3 percent. The rate cut was certainly not stabilization policy in the usual sense, at least not domestic stabilization policy. Rather, it was intended to help calm turbulent world financial waters, which it did wonderfully well.

In a magnificent piece of journalistic exaggeration, the media dubbed this “the 25 basis points that saved the world.” TIME magazine (O’Neill 1999) later featured Greenspan, Rubin, and Lawrence Summers (then Rubin’s deputy) on the cover of its February 15, 1999, issue as “The Committee to Save the World.” Apparently, you could do that, if you were the magical Greenspan, with just 75 basis points of rate cuts (the total amount the Fed did between September 29 and November 17, 1998). Such was the belief in fine-tuning and in Greenspan at the time.

A Separate Peace

Peace also broke out over fiscal policy but not before another bout of fiscal paralysis. Politically wounded by both the epic budget battle of 1993 and the failure of his health care plan in 1994, Bill Clinton and the Democrats suffered a humiliating defeat in the November 1994 elections. While Clinton himself was not on the ballot, numerous Democrats were, and almost all of them lost. Democratic senators, congressmen, and governors fell in droves. Even the Speaker of the House at the time, Tom Foley (D-WA), lost his seat, the first time that had happened since 1862!

When Congress convened in January 1995, both the Senate and the House had Republican majorities; for the House, it was the first time in forty years. House Republicans promptly installed as Speaker Newt Gingrich, the firebrand congressman from Georgia who had led them to electoral victory. Gingrich, a political warrior at heart, teamed up with the far less bellicose Senate majority leader, Bob Dole (R-KS), on a new “just say no” strategy. No to everything.

The 1995 budget season (for fiscal year 1996) opened accordingly, with battle stations manned. The Gingrich Republicans demanded steep cuts in Medicare, Medicaid, and other civilian spending. Clinton and the Democrats refused. In retaliation, Gingrich threatened not to raise the national debt ceiling, which had it actually happened would have thrown the U.S. Treasury into technical default on its debt.

The rancorous “debate,” if you want to grace it with that name, finally produced a continuing resolution to keep the government running until November 13. (Remember, the new fiscal year had already started on October 1.) But the budget war dissolved into acrimony, leading to two (partial) government shutdowns: one for six days in November and the other for a long twenty-two days, including both Christmas and New Year’s Day 1996. From a political perspective, the shutdowns went badly for the Republicans, and Gingrich and colleagues eventually agreed with the White House on a seven-year plan to balance the budget through both spending cuts and tax increases.

The negotiations in 1997 over the fiscal year 1998 budget fared much better. Clinton had won reelection easily, and compromise became the order of the day. There were still major disagreements over budget priorities that ran along the usual party lines. Republicans wanted to shrink domestic spending in areas where Democrats wanted to increase it. Democrats favored defense cuts, which Republicans abhorred. But revenue was pouring into the Treasury from the higher tax rates acting in concert with a booming economy and a soaring stock market that produced bountiful capital gains.6 And Clinton had probably convinced himself by then that deficit reduction accompanied by favorable bond market reactions created jobs, the negative fiscal multiplier once again. A bipartisan agreement seemed possible and was in fact reached in August 1997.

Politically, the Balanced Budget Act of 1997 was touted as a major achievement at the time. It established new spending caps (which were, however, subsequently violated), renewed the PAYGO provision from the 1990 budget agreement, and even made some cuts in Medicare, which were taken as a sign of seriousness. Economically, however, it was not a big deal. In fact, when you examined the details of the 1997 agreement, it actually increased the budget deficit a bit for the first few fiscal years (Blinder and Yellen 2001, 74–76). Nonetheless, the gusher of revenue emanating from the booming economy diminished the red ink rapidly and pushed the budget into surplus.

Table 11.1 displays the deficits projected in January 1997 before the Balanced Budget Act of 1997 passed, the deficits projected a year later after the act had passed, and the deficits actually recorded in subsequent years. Clearly there were some big, pleasant surprises for dedicated deficit reducers.

But the more important policy point is this: while the 1990 and 1993 budget agreements were major landmarks on the path to a sounder fiscal position, the 1997 agreement was, by comparison, small beer that garnered far too much credit at the time. In its December 1997 report, the Congressional Budget Office (CBO) credited it with just $127 billion worth of deficit reduction over five years. (The 1993 budget agreement was closer to $500 billion.) As table 11.1 shows, the budget was already close to balance by fiscal year 1997, before the 1997 agreement took effect.

The Productivity Boom and Greenspan’s “Great Call”

As just noted, the roaring economy helped push the federal budget into the black with amazing speed. Just compare the January 1997 and January 1998 CBO projections for the fiscal year 2002 deficit shown in table 11.1, and remember that the putative goal was to balance the budget in five years. The budget outlook for fiscal year 2002 improved by $257 billion in a single year, and the CBO estimated that virtually none of that was due to policy changes from the 1997 budget agreement (CBO 1997, 1998a). The budget was nearly balanced while the negotiators were still negotiating.

TABLE 11.1. Actual and projected budget deficits, 1997–2002 (in billions of dollars)

Fiscal Year


Projected deficit in January 1997


Projected deficit in January 1998


Actual deficit (−) or surplus (+)











































Source: Congressional Budget Office.

TABLE 11.2. Macroeconomic indicators in the late 1990s



Real GDP growth (Q4-Q4)


Unemployment rate (December)


Inflation rate (December)


Productivity growth (Q4-Q4)*














































Ave. 1996–2000









*Labor productivity in the nonfarm business sector.

Source: Bureau of Labor Statistics and Bureau of Economic Analysis.

The boom of the late 1990s also created millions of new jobs and drove the unemployment rate down to 3.8 percent, marking the first reading below 4 percent since January 1970. Table 11.2 offers a selective snapshot of just how great macroeconomic performance was in the late 1990s. Over the half decade shown there, real GDP growth averaged 4.3 percent per annum, and the unemployment rate dropped to a thirty-year low. Meanwhile, inflation averaged just 2.6 percent, defying predictions that tight markets would foment inflation.

I have already suggested that the Fed’s expert fine-tuning played a role in this spectacular success. But it got a huge assist from another source. The last column shows the remarkable acceleration of (labor) productivity growth from an average of just 1.4 percent over the period 1973–1995 (not shown in the table) to an astounding 3.1 percent over the five years 1996–2000, presumably largely due to rapid advances in information and communications technology. A gain of 1.7 percentage points in the productivity growth rate is gigantic. It gave the economy additional running room that no one anticipated.

Well, almost no one. In fact, Alan Greenspan somehow saw it coming. Skillful monetary policy and rapid productivity growth interacted positively to produce what former Fed governor Laurence Meyer labeled Greenspan’s “great call” (Meyer 2004, chap. 6). At the start of this period, an unemployment rate in the 5.5 percent range was considered a prudent estimate of the nonaccelerating inflation rate of unemployment (NAIRU). For example, the CBO’s estimate of NAIRU in this period was 5.4 percent (CBO 2021; NROU data). Labor markets much tighter than that made inflation hawks—and even a few doves—nervous. Remember, the FOMC had been tightening monetary policy to ward off inflation as recently as February 1995, basing its decisions in part on a Phillips curve with a NAIRU in the 5.5–6 percent range. We thought we had managed a perfect soft landing at full employment.

But then growth accelerated, and unemployment fell even further. Yet Greenspan, the alleged inflation hawk, did not react by raising interest rates. Rather, as Janet Yellen and I put it later, “the best one-word description of the Fed’s monetary policy from early 1996 to the summer of 1999 is forbearance” (Blinder and Yellen 2001, 35). The Fed watched and waited for a rise in inflation that never came. The FOMC’s patience was remarkable on its face and even more remarkable when you remember that Greenspan had been praised in the financial press for acting preemptively against inflation in 1994, that is, for raising rates before inflation rose.

Yet in 1996–1999 with Greenspan unmistakably in charge, the FOMC abandoned preemption in favor of forbearance. As GDP sped along and unemployment fell, even dovish members of the Federal Reserve Board, such as Larry Meyer and Janet Yellen, grew increasingly nervous. (I had left the Fed by then.) Was the Fed already behind the curve? Was it sitting on an inflation pot that was about to boil over?

Shortly before the September 24, 1996, FOMC meeting (note the early date), Meyer and Yellen visited Greenspan in his office to express concern about the inflationary risks the Fed was taking by holding interest rates constant with resource utilization so tight. They told the chair that they thought it was time to start raising rates, albeit gently. Then at the FOMC meeting, they both stated out loud that they were prepared to support a rate increase of 25 basis points if the chair proposed it.7 He didn’t, however, and the funds rate remained where it was—at 5.25 percent. Two years later in September 1998, the funds rate was still 5.25 percent even though the unemployment rate was down to 4.6 percent.

Greenspan’s forbearance derived from his belief that productivity was accelerating, a belief he held well before it appeared in the official data. The numbers in the last column of table 11.2 show that Greenspan’s hunch was correct. But no one knew this in 1996 or 1997. It was an educated guess. Make that a well-educated guess because Greenspan devoured both numbers and anecdotes. He talked to businesspeople, he pored over data that went well beyond the standard macroeconomic aggregates, and at least in this case he saw things that others didn’t.

The idea that faster productivity growth would allow the economy to grow safely—that is, without higher inflation—at a faster speed had been germinating in Greenspan’s mind for a while. The public didn’t hear his speculations on the subject for years. Instead, he posed artfully as an inflation hawk. But those of us on the inside heard him ruminate about the wonders of the “new economy” at several FOMC meetings. At the December 1995 meeting, he put it all together in a lengthy peroration in which he broached what he called “a broad hypothesis about where the economy is going over the longer term.” In his own words, “My idea was that as the world absorbed information technology and learned to put it to work, we had entered what would prove to be a protracted period of lower inflation, lower interest rates, increased productivity, and full employment” (Greenspan 2007, 166–67).

Greenspan later wrote that “this was all pretty speculative, especially for a working session of the FOMC.… Most committee members seemed relieved to return to the familiar ground of deciding whether to lower the fed funds rate by 0.25 percent” (which they did). But when the time for the vote came, I needled him slightly by saying “I hope you will allow me to agree with the reasons you’ve given for lowering the rate without signing on to your brave-new-world scenario, which I am not quite ready to do” (Greenspan 2007, 167). In his memoir, Greenspan referred to the person who made this cheeky remark as “one of our most thoughtful members.” Thank you, Alan. But I was wrong.

In retrospect, I should have signed on to the brave new noninflationary world scenario right then and there. In December 1995, however, the data didn’t show it—not even close. Nor did the data show it in 1996 and 1997. Unlike Greenspan, I didn’t like to base decisions on hunches. Like Larry Meyer and Janet Yellen—all three of us academic economists—I wanted to see it in the data.

Figure 11.3, which depicts data from Blinder and Yellen (2001, 61), shows just how long we data guys had to wait. The lower line is the point estimate of the break in the upward trend of labor productivity in a series of conventional output-and-hours equations, each ending in a different quarter. These estimates bounce around a bit, but calling them all “about 1 percent” right through the end of the 1990s does not do great violence to the estimates. It’s the t-ratios (for statistical significance of the break in trend), shown in the upper line, that are more interesting. Using the conventional benchmark of t > 2, an econometrician would not have been ready to declare an increase in trend productivity until the third quarter of 1998, if then. Greenspan was there years earlier, which is why Meyer called it Greenspan’s “great call.” Thanks to that call, millions more Americans found jobs in the late 1990s.

FIGURE 11.3. Estimated break in the productivity trend and its t-ratio (regressions ending in quarter indicated).

Source: Blinder and Yellen (2001).

There was, however, at least one loose end in Greenspan’s analysis. Faster productivity growth alone will raise the economy’s speed limit, that is, the long-run growth rate that the economy can sustain without straining resources too tightly. Roughly, that’s the sum of labor force growth plus productivity growth. However, when the economy grows at that rate, the unemployment rate should remain stable, which is far from what happened in the late 1990s. Rather, unemployment kept falling, indicating that resource utilization was tightening. Yet there were no inflationary consequences, just as Greenspan had speculated at the December 1995 FOMC meeting.

The Rise of Central Bank Independence

In addition to the wonderfully long-lasting boom, the 1990s witnessed an important and almost worldwide revolution in thinking about the respective roles of central banks and elected politicians in making monetary policy. It was in this decade that central bank independence came to dominate both thinking and practice.

The United States, of course, had an independent central bank well before the 1990s. But it is a myth to think that central bank independence had a long and illustrious history here. Nor is it enshrined in the U.S. Constitution. There are nations in which the independence of the central bank has constitutional protection, but the United States is not one of them. Rather, the Constitution gives Congress the power “to coin Money” and “regulate the Value thereof” (Article I, Section 8). In the Federal Reserve Act of 1913 and its many amendments since then, Congress has delegated that authority to the Fed, which has de facto independence. But those are just ordinary statutes that Congress can change at any time. Delegated power can be reclaimed.

We have seen early in this book (especially chapter 1) that there was far from uniform belief in Federal Reserve independence in the 1960s and 1970s. Economists with views as disparate as James Tobin and Milton Friedman opposed it. Even the Fed’s longtime leader, William McChesney Martin, saw the Fed as part of the economic “team.” Importantly, however, monetary policy decisions were in fact made by nonpolitical technocrats on the FOMC. Martin established some measure of de facto independence when he defied President Lyndon Johnson in 1966.

The 1970s probably marked the nadir of central bank independence in the United States. As we saw in chapter 4, President Nixon installed his friend Arthur Burns as chair of the Fed in February 1970. Unlike Martin, Burns had long-term relationships with Republican politicians in general and with Nixon in particular. He seemed to make monetary policy subservient to the political needs of Nixon, which is the antithesis of independence.

After the brief Miller interlude in 1978–1979, the indomitable Paul Volcker took over at the Fed and quickly reasserted the central bank’s independence. Notice that there was no change in law. Nor was there even a change in the presidency; Jimmy Carter appointed Miller first and Volcker second. But there was a huge change in the personality and intestinal fortitude of the Fed chair and in his dedication both to fighting inflation and to asserting the independence of the central bank. As noted in chapter 8, both President Reagan, who inherited and then reappointed Volcker, and his right-hand man James Baker found Volcker’s degree of independence annoying, to say the least. One suspects that they thought the more political Alan Greenspan would be more pliant.

If so, they were probably disappointed. As noted in this chapter, the George H. W. Bush administration and the Greenspan Fed were often at loggerheads. So, while the Federal Reserve acted independently during the Bush administration, the White House chafed at the Fed’s independence and tried to undermine it with rhetoric.

The next watershed for central bank independence in the United States came in the early days of the Clinton administration when, as observed in this chapter, Bill Clinton held—or maybe bit—his tongue when the Greenspan Fed started raising interest rates in February 1994. Throughout his eight-year presidency, Clinton rarely deviated from the mantra “we don’t comment on the Fed.” While it is unlikely that a warm feeling ever developed between the back-slapping Democratic pol from Arkansas and the stiff Republican Fed chair from Manhattan, Clinton nevertheless reappointed Greenspan in 1996 and again in 2000. By then, Greenspan had become an institution. Years later in October 2007, Senator John McCain (R-AZ), who would become the Republican presidential standard-bearer in 2008, jokingly declared Greenspan to be indispensable: “If he’s alive or dead, it doesn’t matter. If he’s dead, just prop him up and put some dark glasses on him, like ‘Weekend at Bernie’s’ ” (Boston Herald 2007).

If you looked around the world at the end of the 1980s, the Federal Reserve, the Deutsche Bundesbank, and the Swiss National Bank stood out as almost the only independent central banks on earth. (New Zealand would follow soon.) In other major countries, monetary policy was either made by (e.g., the United Kingdom) or heavily influenced by (e.g., Japan) the president or prime minister’s office. But such arrangements changed rapidly and decisively in the 1990s. By the decade’s end, all the advanced industrial countries of the world and many of the emerging market ones had made their central banks independent.

The reasons behind this highly consequential change in economic governance were numerous. Perhaps paramount was the high inflation rates of the 1970s and 1980s. Bodies politic and their elected officials everywhere grew unhappy with high inflation, saw that it did them no good (e.g., there was no long-run gain in employment), and searched for a way out. Looking at the German and Swiss (and, to a lesser extent, the American) examples, they saw lower inflation rates without higher unemployment rates. Some politicians may even have been acquainted with scholarly research establishing that same nonrelationship statistically.8

Geopolitical events also played major roles. When the Soviet Union collapsed in 1991, the former Soviet satellite nations suddenly found themselves without any “monetary policy,” a job that had previously been handled from Moscow. These new nations needed to do something about monetary and financial policy, and establishing an independent central bank seemed an attractive option. Remember, one of them was East Germany, which had the successful West German model at its doorstep.

A year later, twelve member nations of the European Union signed the Treaty of Maastricht that, among other things, set them on a course toward a common currency and, of course, toward a single central bank. Establishing an independent national central bank was among the Maastricht requirements. (The Bundesbank was clearly the model.) France made its central bank independent in 1993, Spain followed in 1994, and so on.

The United Kingdom dropped out of the process that eventually led to the creation of the euro and the European Central Bank in 1992. But the UK government nonetheless freed the Bank of England to make monetary policy independently almost immediately after Labour’s smashing electoral victory in 1997.9 “Independent but accountable” was the United Kingdom’s mantra. The Bank of Japan followed suit the next year. Thus, by late 1998 almost all major nations had independent central banks.

The intellectual currents of the day may also have played a role in the sharp turn toward central bank independence. The notion that political control of money produced too much inflation was hardly a revelation; sovereigns had been “clipping the currency,” whether literally or figuratively, for centuries. If you followed that political economy logic a bit further, it led to the idea that it might be better (in the Pareto-dominating sense) to let technocrats make monetary policy rather than politicians.

Finn Kydland and Edward Prescott had dressed this old argument up in new rational expectations clothing in 1977. Their celebrated paper on “time inconsistency” in monetary policy (Kydland and Prescott 1977), the idea that central bankers might reach for short-term employment gains at the cost of higher long-term inflation, garnered a huge amount of attention in academia, eventually leading to a Nobel Prize for the pair. But all that fuss led some academics to give the Kydland-Prescott analysis far too much credit for the trend toward independent central banking. They forgot, for example, that both the Volcker disinflation in the United States and the Thatcher disinflation in the United Kingdom were entirely discretionary, not rules-based in the least. The latter was even accomplished by an elected politician, as the Bank of England was subservient to 10 Downing Street at the time. Kydland and Prescott’s time-inconsistency analysis is one of the starkest examples of an idea that sweeps academia but makes barely a ripple in the real world of policy making.

Whatever the reasons or, more accurately whatever the weighting of the various reasons, central bank independence, which was rare in 1990, became the norm by 1998. In a world such as that of central banking, where change typically comes at a glacial pace, this was blazing speed.

Chapter Summary

The 1990s began with a recession but ended with the tightest labor markets the United States had seen since 1969.

The public was slow to recognize that the recession ended early in 1991. That misperception, enhanced by the fact that the recovery was “jobless” at first, contributed to George H. W. Bush’s defeat at the polls by Bill Clinton in November 1992. Bush, however, blamed Alan Greenspan and the Fed for cutting interest rates too slowly. During the last two years of Bush’s presidency, administration officials bashed the Fed incessantly and in public.

Relations between the White House and the Fed warmed dramatically during the Clinton presidency. Clinton’s aggressive 1993 target for deficit reduction was actually suggested by Greenspan. The financial markets loved the program, and bond rates fell. But Republicans in Congress “just said no,” and Democrats picked Clinton’s budget proposals apart. In particular, they rejected Clinton’s idea to shield the economy with a small short-term fiscal stimulus. Keynesian fiscal policy was deeply out of fashion at the time. Even without the stimulus, that first Clinton budget barely squeaked through Congress without a single Republican vote. It turned out to be wildly successful, however. The budget deficit melted away, and the economy grew strongly.

Clinton was enraged when the Fed began to raise interest rates in February 1994. But unlike Bush, he held his tongue: We don’t comment on the Fed. Over the course of a year, the FOMC raised the federal funds rate by 300 basis points, which turned out to be exactly the right amount, leading to a perfect soft landing at about 3 percent inflation and about 5.5 percent unemployment. Economists at the time thought that was about as good as it gets. But then things got better.

The late 1990s were a period of above-trend growth, falling unemployment, and stable inflation. One key to this success was a sharp acceleration of productivity after 1995, presumably a result of the information technology revolution and of Greenspan’s belief in that acceleration long before the data showed it. Trust in the Fed’s ability to steer the economy with discretionary monetary policy reached fantastic heights during this time.

While Alan Greenspan’s position in the United States may have been unique, one nation after another made their central banks independent in the 1990s, and none have gone back to political control of money. In stark contrast, the idea of using discretionary fiscal policy to manage aggregate demand continued its vanishing act. Instead, many Washington hands started to believe (and to say) that reducing the deficit was the way to “grow the economy.” Those wonderful days for the U.S. economy were dark days for Keynesianism.

Then came the election of President George W. Bush, and everything changed.


1. See Greenspan (2007), especially chap. 5.

2. I left the Clinton administration in June 1994 to join the Fed.

3. Full disclosure: I was vice chair of the Fed throughout this period.

4. More disclosure: I was instrumental in getting those words into the FOMC statement. Greenspan thanked me at the time, but I’m not sure he thanked me later as markets interpreted—and sometimes misinterpreted—the FOMC’s words.

5. This I know for sure. I was there.

6. To cite just one dramatic example, the Internal Revenue Service took in $36 billion from taxes on capital gains in 1994. By 1998 that was up to $89 billion, and it topped out at $127 billion in 2000. See Tax Policy Center (2017).

7. The story is told in Meyer (2004).

8. Alesina and Summers (1993) was probably the best-known at the time. But others, such as Bade and Parkin (1988) and Grilli et al. (1991), had earlier found that more independent central banks were associated with lower inflation.

9. In return for gaining monetary policy independence, the Bank of England relinquished its traditional authority over bank supervision and regulation.

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