Published December 1, 1994 | December 1994 issue
Since leaving the relatively subdued halls of academia for Washington, Alan Blinder has been in the fray of two economic maelstroms. First, he was a member of the president's Council of Economic Advisers during the administration's efforts to reduce the deficit while generating economic activity; then he joined the Federal Reserve's Board of Governors in June 1994, in the middle of the Fed's much-watched attempts to stem inflation.
In the following interview, Blinder shares his thoughts on life at the White House, the Fed and as a college professor. He also talks about inflation, unemployment, his political philosophy and the importance of economic education. The former columnist for Business Week also discusses the necessity for clear economic writing.
Region: During the confirmation hearing for your position at the Fed, you referred to the millions of Americans who haven't the slightest idea of what the Fed does, but who are nonetheless affected by its decisions. Should the Fed care about those Americans' ignorance of their central bank? If so, what can the Fed do?
Blinder: I think we should care. There is relatively little we can actually do in the way of education, although we can do some. We're not primarily an educational or a public relations agency, as you know. I think what we can really do and should do is to perform our role of economic stewardship well. That is, we inside the Fed are supposed to know what the Fed does, at least I hope we do. And we should guide the economy with the best interests of those millions of people in mind.
Region: In Hard Heads, Soft Hearts, you write that there is apparently something in the American character that rejects any remedy too complex to be emblazoned on a T-shirt. How does this attitude impact economic policy?
Blinder: It leads to simplistic solutions. Sometimes those are from the left, sometimes those are from the right. That doesn't much matterthey're both wrong. And the fact that the basic level of economic literacy in the country, indeed in the world, is so low is one of the things that leaves the political process so vulnerable to this malady.
Region: Is that due to the politicians, or do economists co-opt themselves in that process?
Blinder: I think it's more due to the politicians than to the economists. But I think the economists, with some exceptions, don't help a lot in that they spend precious little time talkingand I guess that means through the mediato ordinary people in ways that ordinary people can understand. It's also due to what I see as some failures in our educational system. Too many American kids are brought up without any basic literacy in economics. I don't mean knowledge of fancy economic theory, I mean fairly elementary things like "demand curves usually slope down." You don't have to be a rocket scientist to understand that concept.
Region: Does this T-shirt attitude impact the Fed?
Blinder: I think it impacts the Fed relatively little. For a pretty simple reason: We're not a political organization, and people in the Fed don't make decisions by reading public opinion polls. It impacts the Fed some because we often get criticized based on simplistic sloganeering. But, when that happens, I think it has relatively little impact on policy. If you are in the political arena, you can't ignore T-shirt attitudes as easily as you can when you are in an apolitical arena. And this place is pretty apolitical.
Region: In recent decades, economics has given us Keynesian theory, monetarism, rational expectations and supply-side economics. What are your assessments of these theories and what have they taught us?
Blinder: Well, that question doesn't lend itself to a short answer! Any decent answer to that question would take at least an hour and a half. Let me see if I can give you the Cliff Notes version of the answer. First, a lot of evidence, some experimentation and, quite simply, a number of real-world events have made it clear that monetarism won't do. By monetarism I mean quite serious, if not single-minded, concentration on the monetary aggregates as guideposts for policy. One can debate whether monetarism once did do, and it's interesting to speculate about whether it might do sometime in the future, which is possible. But I think there is essentially unanimous agreement that it won't do now. So that one is fairly well answered.
The verdict on rational expectations is more up in the air. It's a phrase that means different things to different people. The 1970s version of that hypothesis, the one that got associated with extreme views of monetary policy suggests that monetary policy can't have any effects on the real economy unless it takes people by surprise. I believe this has been pretty much vanquished by the evidence. Other aspects of rational expectationssuch as the question: Are the subjective expectations in the heads of decision-makers the same as the objective expectations that a capable statistician would generate from up-to-date statistical techniques and data?are still open questions. I think, frankly, that the weight of the evidence is against rational expectations. But the issue is by no means closed and research needs to continue.
Supply-side economics, as that phrase came to have meaning in the early '80s, is, I think, by now widely viewed as a bad joke. A bad joke because it actually got tried, and it backfired in a terrible way. It was never a serious intellectual doctrine, then or now. That is not to say there aren't important things on the supply-side of the economy that government sometimes influences inadvertently and adversely and could influence better with smarter policies. There could have been a meaningful supply-side economics, and to some extent there is. People who spend a lot of time talking and worrying about productivity and what we might do to increase it are practicing the right kind of supply-side economics. But the kind of supply-side economics that got associated with massive irresponsible tax-cutting reflects a naive view that the solution to every problem is to cut taxes. This was a terrible idea and did us a lot of damage.
The bottom line is that all this leaves us with Keynesian theory, which is where we started before all these other things flared up. It has survived these intellectual revolutions modified in significant ways but largely intact; that is to say, the Keynesian view of the economy, as many people hold it today, is different in a number of ways from the Keynesian view of the economy that people held in 1964definitely different. It is, for example, definitely more modest in the claims of what it can accomplish. But, as pure intellectual doctrine, it still looks amazingly similar to vintage 1964 Keynesianism.
Region: What areas of research would you like Fed economists to investigate, specifically, any questions regarding monetary policy?
Blinder: There are all kinds of questions, and they keep coming up almost literally every day. We have questions now about the relationships between interest rates on bank accounts and open-market interest rates; the former seem to be lagging behind these days. Of course, we have constant questions about the behaviors of the various Ms relative to the economy. There are questions about where all the currency is goingwe think much of it is going abroad. There are questions about why long-term interest rates have responded so differently to the recent monetary tightening than would have been expected from past behavior. Indeed, you can broaden that to other aspects of the financial markets, including the stock market and the foreign exchange markets. There are questions about linkages, or lack thereof, between financial market prices in the United States and elsewhere. There are questions about the quite notable buoyancy of investment spending. I could go on and on. We have a big staff investigating lots of things.
Region: Economists at the Minneapolis Fed have advocated a reform of deposit insurance where 100 percent insurance is limited to a certain amount in only one account per person after which depositors assume some of the riska form of coinsurance. Is such reform necessary?
Blinder: I think when you ask whether such reform is necessary, it makes it an easy question. The answer is: I don't think so. The current system, including the changes in bank supervision that come under the rubric "prompt corrective action," has left us with a system that, as they say, "ain't broke." So there is no particular reason to fix it. So, when you say "necessary," I think that makes it an easy question.
The harder question is: Would a system of deposit insurance like you mentioned be better than what we have now? I think that is a debatable proposition. I come down thinking it wouldn't be better, for a variety of reasonsthe most important of which is that most people have better things to do with their time than studying the safety and soundness of their banks to decide how much at risk their money is. I think there are large economies of scale in having that function performed by bank regulators rather than by individual depositors. But you can make an argument on the other side. I consider it a debatable proposition.
Region: In recent years there has been some debate over the question of fixed vs. floating exchange rates. Is there a good case for returning to fixed rates?
Blinder: I think there is a good case in principle and a poor case in practice. Think of the 50 states of the United States. We have fixed exchange rates. The Minnesota dollar and the New Jersey dollar exchange at parthey have for a long time and there is a belief that they always will. That's the best kind of exchange rate system you can have. But you can have it only when the economies, in this case Minnesota and New Jersey, are totally integrated. Capital can flow completely freely between Minnesota and New Jersey; so can people; so can goods. And the monetary policy of Minnesota and the monetary policy of New Jersey are the sameit's the monetary policy made here in Washington for all the states. Everybody believes that that will be true essentially forever. If you can get to a system like that, then fixed exchange rates are terrific because they remove an element of uncertainty over trade.
However, when you start thinking about fixing exchange rates across countries with different political authorities, the politics change and therefore the policies change. There are also various barriers to the movement of people, goods and money that also change through time. And, most importantly, there are different monetary policies across the different countries. In a world of nation-states like that, I think pursuing fixed exchange rates is pursuing a chimera, that is, it's unattainable. If you try to create such a system, it will crack.
Region: Across the United States, one of the most important development issues is the competition among city, county and state governments to attract and retain businesses. Those government entities are competing with sweetheart deals on financing, taxes and infrastructure, for example. Is this good economic development policy?
Blinder: I think this is one of those classic examples of the fallacy of competition. It may well be good economic development policy for a particular city or county or even a state to do this, but I'm very far from convinced that it is good for the nation. To a very great extent, this is a zero-sum game. Local jurisdictions are competing against other local jurisdictions, sometimes in a race for the bottom, which I think is to the detriment of society as a whole.
Region: From what you have said in the past, zero inflation may not necessarily be zero percent, what do you mean by zero inflation? Are we close to achieving that in this country and is zero percent inflation possible?
Blinder: I have a very simple conceptual definition of zero inflation, which is not necessarily numerical: It's when ordinary people in their ordinary course of business stop thinking and worrying about inflation. By that definition we are probably close to, but not quite at, zero inflation today. You can sort of hear it in conversation and feel it in the air. The truth is that ordinary Americansconsumers, workers and business peopleare talking and thinking very little about inflation now. However, there is still some concern. So the answer to the question, "Are we close to achieving it?" is: Yes, we are close but not quite there. What would price stability mean in terms of numerical measurements in the price index? I suppose 2 percent or less, but I'm not sure. Is zero inflation possible? Yes, it is. With a sufficiently contractionary monetary policy, we can push this economy not only down to price stability by the definition I just suggested, but actually to a zero change in the Consumer Price Index. We would have to pay a heavy price to get there, however.
Region: Is there a consensus view on what the natural rate of unemployment is? What significance does the rate have for monetary policy?
Blinder: I think there is a gathering consensus, although it is far from a unanimous opinion, that the natural rate of unemployment is somewhere pretty close to where we have been in recent monthssay between 5.6 percent and 6.2 percent. You will find the vast majority of opinion in that range. In that sense, I think there is a fairly strong consensusas long as you don't mean pinning it down to a precise number.
Region: The second part of that question: the significance of the rate on monetary policy?
Blinder: Yes, well, monetary policy ought to be trying to get unemployment down to the natural rate, but not to overshoot it. In terms of operational monetary policy, that means different things under different circumstances. Right now, I think it means trying to keep the economy on an even keel growth path and maintain the unemployment rate pretty close to where it is now.
Now, we don't have the ability to fine-tune the economy. We don't have the ability, even if we decided that we knew the correct rate exactly, to hold unemployment exactly there month after month. But we can try to keep it in the neighborhood, which to me means, say, not to let it shoot up to 7 percent and not to let it tumble to 5 percent. Much as I would love to have 5 percent or even 2 percent unemployment, we're pretty sure we can't get there without accelerating inflation; and the Federal Reserve is supposed to prevent accelerating inflation. So I would say that to keep the economy reasonably close to the natural rate most of the time is one important goal of monetary policy. The other one, of course, is price stability, as we just discussed.
Region: To what degree is the U.S. inflation rate and the subsequent attempts to control inflation, impacted by foreign markets, foreign affairs?
Blinder: I am tempted to say "much less than is often supposed," but I guess it depends on who is doing the supposing. There are still some people who think of the United States as a closed economy and don't ever think about the foreign sector. And those people, of course, underestimate the importance of foreign influences. On the other hand, there is a tendency, at least among educated elites in this country, to actually overstate the degree of foreign influence and forget about some elementary factssuch as that 90 percent of the goods and services that Americans buy are American made. Conversely, roughly 90 percent of the things that Americans make are sold to Americans. That means that the vast majority of the determinants of inflation are homegrown.
So, yes, we can import a little inflation from abroad, or we can import a little deflation from abroad, depending on what's going on in the rest of the world. But, except for really major upheavals like the oil shocks of the '70s, it is most unlikely that those effects can have a very large impact on the inflation rate in the United States.
Region: The Community Reinvestment Act, derivatives, interstate banking and branching, banks selling mutual funds with buyers unaware, these are hot buttons right now in the banking industry. In the short time that you have had to analyze these issues, what is your assessment of them? Is there something the Fed should be addressing immediately?
Blinder: I think they all have a degree of importance. CRA is one we are addressing immediately. As you may know, the Federal Reserve and the other bank regulators have put out a new set of proposed CRA regulations for public comment and will be getting those comments back in about a month and a half. [Note: The interview occurred in late September.] These regulations are meant to be a Solomonic compromise between the desire for objectivity and the desire not to rigidify. Unfortunately, and in somewhat direct conflict, there is also meant to be a Solomonic compromise between the needs of community groups for more activism by the bank regulators and the need of banks for less paperwork. We have tried to compromise all of that.
Derivatives are getting a tremendous amount of attention in the central bank, in government, and in the media. My view, and the strong majority view held around here, is that it is very much premature to be legislating on this issue, as many people want to do, because we don't yet know what kind of legislation makes sense. I don't rule out the possibility that at the end of the day some legislation, and certainly some changes in Federal Reserve regulations, will make sense. I think we are a long way from knowing what kind of legislation makes sense, and until you have a strong belief that by legislating you can do more harm than good, I don't think you should be legislating.
You mentioned mutual funds. I think there is some evidence that there is a problem there. The problem being that too many consumers don't understand, when they walk into a bank lobby, the difference between putting their money into an insured deposit and putting their money into an uninsured mutual fund. The regulators and the banks have got to bend over backwards to poke people in the eye, kick them in the ribs, kick them in the knee, hit them over the head and make sure they understand that there is a big difference. It's not easy. Bankers can go to great lengths and still some people don't get the message. They just have to try harder, and we've got to try harder. We'd all be derelict in our duties if we just let people that didn't know what they were doing stumble into mistakes like that. As long as the people know what they are doing when they take their money out of an insured deposit and put it into a mutual fund, I think that's just fine. I think it's perfectly fine for the bank to provide those services. I'm not against any of that. But I think we have to expend a tremendous amount of effort making sure that people know what they are doing.
Interstate banking, from the legislative point of view, is now largely over. There is still plenty of work for the bank regulators, because there is every reason to expect a huge explosion in interstate acquisitions, branching, mergers, all kinds of things. Those will present us with fairly familiar issues. But where this really is a big deal right now is in the banks themselves. Banks all over America must be thinking about their business plans in view of the greater ability to branch across state lines or make acquisitions across state lines. What should they do? That's for the bankers to think about.
Region: In the 1990 book, Paying for Productivity, you described this country's productivity performance in the 1970s and '80s as dismal. Why was that the case and what does that mean for the economy as a whole? Is there any evidence for current improvement, or improvement in the future?
Blinder: The answer to the big questionwhy was that the case?is that nobody knows for sure. A number of culprits have been talked about and isolated. But nobody knowledgeable about the subject thinks we have a full list, with appropriate weightings on each, of the various causes. One of the culprits, although I have to admit it doesn't come close to telling the whole story, is energy costs, which rose a lot in the 1970s. But, of course, they have fallen a lot since then. Another one of the causes is failures of the educational system. Another is inadequate private and public capital investment. The first of those, private investment, is being largely addressed now, for we are in the midst of a capital spending boom. The latter, I think, is also being addressed but only in minor ways because of the severe problems with the federal budget. The Clinton administration certainly wants to redirect more resources toward public capital and has, in fact, had some success in that regard. But the administration is quite limited by the tight budget.
The sad truth is that nobody has anything close to a full, convincing explanation for the slowdown in productivity growth since the '70s. That's the bad news. The good news is that a number of the factors that we can understand seem to either have turned, or seem to be turning, in a good direction. The most obvious one is private investment, as I just said. Although the evidence is certainly not unequivocal on this score, the data do look to be showing some rebound from the dismal sub-1 percent per year productivity gains of almost two decades to something better than that. But we're certainly not anywhere near the productivity growth rates of the '60s.
Region: You have described your ideological foundation as grounded in the notion of sympathy for the underdog, which calls to mind the approach to economics that you term "hard heads, soft hearts." Please describe this approach to economics.
Blinder: What it means to me is that there are certain segments of society that I characterize as "underdogs" who need help from the government, and there are lots of other people who don't. Those people who don't need help are well-educated, productive, intelligent. There are many such people who earn a good living and don't need any government aid to help them do it. But there are lots of other people who are born in very adverse circumstances, or with less ability, or sometimes with physical or mental handicapsa whole variety of things that make them less productive in the marketplace. And I believethis is just a bedrock-philosophical belief that society, working through government, has some obligations to help these people live a better life. That's the soft heart.
On the other hand, one wants to do all this in intelligent, efficient and cost-effective ways. Why? Because, if you don't do that, you first of all are going to damage the efficiency of the economyand that's the goose that lays all the golden eggs. Second, you're going to waste the taxpayers' money, which is something I take very seriously. So that's the hard heads part of the dictumthat we want to help the underdogs, but do it as efficiently as possible.
Region: Much economic writing is arcane and perhaps necessarily so, but your columns in Business Week and other published works have garnered praise for their readability. One critic said your 1987 book, Hard Heads, Soft Hearts, exhibited "graceful English prose," three words not generally associated with economic literature. If it's true that most economic writing is unapproachable by the general public, even an interested and relatively educated public, what are the ramifications, if any, for the field of economics?
Blinder: Well, I believe that a society that has a higher average level of economic literacy will produce better economic policies because the people will demand more of their legislators. In a democratic system, legislative bodies do indeed respond to the electorate; I really believe that. So there's a real sense in which people in this country get the economic policy they deserve, or more properly put, get the economic policy that they clamor for. If the public as a whole had a better understanding of economics, and if more economists were writing "graceful English prose," that would help a little bit and better economic policies would be produced by the political system. Now, the unfortunate part is that's easy to say and not easy to do. First of all, you have to get people writing it. Secondly, and even harder, you have to get people reading it. And when the choice comes down to Sports Illustrated or the economists, I think it's easy to see what most Americans will pick.
Region: Over the years, your writing kept you in the middle of the public fray when it came to economic policy debates. Since joining the Council of Economic Advisers (CEA) and then the Fed, have you missed the opportunity to independently comment on economic policy through your columns and other writings?
Blinder: Yes, I think so. But there are compensations. For example, there are lots of things that I have had access to at the CEA and here at the Fed that I could never come close to having when I was a ... let's call it a normal person. On the other hand, I do miss the freedom. Especially at the CEA, but also here, you sacrifice a lot of your freedom of speech. And as someone who was used to having freedom of speech in a very extreme forum, that's a very big transition. Almost nobody in our society has as much freedom of speech as a tenured professor in a university has. I had that for long time and got used to living that way. But I don't have it any more.
Region: In addition to monetary policy, what else are you working on at the Fed?
Blinder: Well, as you know, but the public at large doesn't appreciate so much, a lot of what we do here reflects the fact that we're a bank regulatory agency. So, if you're on the Federal Reserve Board, you have no choice but to get involved up to your neck in a whole range of regulatory issues, several of which you already asked me aboutderivatives, CRA, mutual funds, disclosures. There are other issues having to do with bank mergers and acquisitions, payment systems, international regulatory issues, and just a whole host of things that keep coming through the door. If you do nothing but count the pieces of paper that come into my office, it's overwhelmingly true that much more comes in having to do with bank regulation than has to do with monetary policy.
Region: Has anything about the Federal Reserve surprised you? Are there striking similarities or differences about the Fed, the White House and academia?
Blinder: I think I've had a lot of quantitative surprises, not any qualitative surprises. Let me explain what I mean. I came to the Fed with my eyes open and knowing a fair amount of what goes on here. If you look back historically, some people come to the Fed more or less as strangers, not really knowing the institution. I was never a Fed insider before I went on the Board, but I knew quite a lot about the Fed. So I don't think I've had any qualitative surprisessomething that is just totally different and that I was completely unprepared for and shocked by. But I've had quite a few quantitative surprises. The place is more formal, more hierarchically structured, than I realized. I want to stress again that this was quantitative. I knew the Fed was formal, I knew it was hierarchical. But not quite so much.
Similarly, the volume of the bank regulatory paperwork is greater than I realized. Again, I realized that it was there; that was no surprise. But the volume and, I might say, the complexity surprised me. Not all of these issues are so simple that they just come to your desk, you look at them for five minutes, and you see the obviously right thing to do. A lot of things are much more complicated than that; they take time, and they take thought. Again, did I know that before I came to the Fed? Yes, absolutely. But I didn't have a good notion of how complicated and how many issues and how much time it would take.
Except for the formality and the hierarchy, I think it may surprise you if I say that I think the differences between working at the Council of Economic Advisers and working at the Fed are actually bigger than the differences between working at the Fed and working in academia. The reasons for that are several. As I said before, this is really a non-political institution. We argue about policy decisions and have differences of opinion. But these differences are argued largely on their economic merits, just as we argued economic debates on their economic merits back in the academy. Politics, in a partisan sense, essentially never enters. That, of course, can never be true in the White House. That's not a particular statement about the Clinton White House, it's a generic statement about any White House. It's the center of the nation's political activity.
Another thing that is generically true is that a White Houseagain, any White Househas to be worried tremendously about its public relations image, its press image, its message. That's not something that a professor ever worries about, and, frankly, the Federal Reserve doesn't worry too much about it either. We do things and we make decisions, but we don't spend a lot of time on spin control. It's just not what the Federal Reserve does.
The pace of life here is also much closer to academia than it is to the CEA, where there was just a constant demand for instant information needed to inform decisions. In the Council's case a "decision" was always what to recommend to the president, for the Council of Economic Advisers doesn't have any decision-making power. But there was a constant demand for very, very fast recommendations. The Federal Reserve is much more contemplative. It operates at a much slower pace, more the pace I was accustomed to. You actually have time to think about things! When you're a professor, you're allowed to give the answer, "I don't know the answer to that, let me think about it." At the Federal Reserve, we can sometimes also afford the luxury of not giving an answer right away. That's another sense in which life here is more like the academy than at the White House.
Region: Thank you, Mr. Blinder.
More about Alan Blinder
On leave from Princeton University, where he was Gordon S. Rentschler Memorial Professor of Economics, and where he has taught since 1971.
He has authored or co-authored 10 books, including Hard Head, Soft Hearts; Growing Together; Economics: Principles and Policy (with W.J. Baumol); and Toward an Economic Theory of Income and Policy.
From 1985 until he joined the Clinton administration as a member of the Council of Economic Advisers, Blinder wrote a monthly column for Business Week magazine.
He earned his bachelor's degree at Princeton, master's at the London School of Economics and doctorate at Massachusetts Institute of Technology.