Inside the FOMC: in his new book, a former Fed governor provides a rare glimpse of the inside workings of the Greenspan Federal Reserve.

• Author: Meyer, Laurence

When I was sworn in as a governor on June 20, 1996, the economy was in the sixth year of an expansion. The Dow Jones Industrial Average was up more than 20 percent for the year, manufacturing was picking up steam, and home sales were hitting their highest marks in a decade.

But in the cool confines of the Federal Reserve, the celebration was muted. Already, many staffers were worrying that the strong growth and low level of the unemployment rate would soon encourage workers to demand higher wages. Those demands, in turn, would begin fueling inflation, which had burned through the economy with such destructive force in the 1970s and 1980s.

With the economy growing strongly and already near full employment, the mission of the Fed was to encourage a "soft landing." In economic terms, a soft landing occurs when growth slows--just as the economy reaches full employment--so that the unemployment rate remains steady. If inflation is also low enough, at this point, then the FOMC has achieved its two primary objectives, full employment and price stability. (1)

It's analogous to an extraordinarily smooth aircraft landing, so perfect that you want to applaud the pilot: In this case, the pilot is the FOMC, the airplane is the actual output of the economy, and the runway is the maximum sustainable output of the economy.

In the best of all worlds, the FOMC pilot should be able to bring a soaring economy right down onto the firm surface of the maximum sustainable level of output--without blowing out all the tires. Unfortunately, as 1 learned over the next few years, it takes a lot more luck to land an economy than it does an airplane.

Nevertheless, it was the issue of bringing the economy down to earth that dominated my first FOMC meeting on July 2 and 3, 1996. Walking into the Fed, you get the feeling that important business is being done here. And so it was that day.

AS ALICE RIVLIN and I entered the room, we were welcomed warmly into the club. I had already met the other Board members--Mike Kelley, Larry Lindsey, Susan Phillips, Janet Yellen, and, of course, Alma Greenspan--but I had previously met only a few of the Reserve Bank presidents.

The senior Fed staff members were also milling about--including Mike Prell, in charge of preparing the staff forecast of the U.S. economy; Ted Truman, director of the Division of International Finance, in charge of monitoring developments in foreign economies; and Don Kohn, director of the Division of Monetary Affairs, in charge of providing guidance about policy options. Prell, Kohn, and Truman played an important role in preparing the Board members for FOMC meetings. They also provided guidance to all the Committee members during meetings. As a result, they wielded considerable power. For that reason, as I have mentioned, they have been dubbed "the Barons."

A few minutes later, Greenspan entered the room and walked immediately to his place at the imposing mahogany meeting table, signaling everyone else to take their respective chairs. He already had his game face on, that inscrutable expression behind reflective glasses. The Chairman, I noted, entered from a door that connects to his office. The rest of us entered through the main door of the boardroom.

I FIRST MET the Chairman in December 1994, when I was invited to sit on a panel of academics and present my views on the outlook and monetary policy to the Board. I had seen him three times since then, once at another academic panel discussion at the Board, again at the ceremony for my nomination as governor, and finally at my confirmation hearing. But I had never been in the inner circle before. Now I was about to learn the secrets of the temple. (2)

AS WE SAT DOWN for my first FOMC meeting, I noted that Norm Bernard, the deputy secretary of the FOMC, was seated to the Chairman's right. He was there to keep the agenda on track, help the Chairman determine whose turn it was to speak next, read the proposals as they came up for a vote, and conduct the roll call vote. To the right of Bernard was William McDonough, president of the Federal Reserve Bank of New York, the Vice Chairman of the FOMC, and a permanent member of the Committee. (3) To the left of the Chairman was Alice Rivlin, the new Vice Chair of the Federal Reserve Board.

The remaining governors of the Board were seated relative to the Chairman according to their seniority on the Board. Just so they didn't get it wrong, their names appeared on little plaques on the chairs. The other Reserve Bank presidents also sat around the table in a prescribed order, for which no one could seem to remember the logic. The staff Barons also had a place at the table, while the other members of the staff were seated in chairs on all four sides of the room.

Now I noticed a green light come on in front of the deputy secretary, indicating that the meeting was being recorded. First, Alice Rivlin and I were formally welcomed by the Chairman. Then Peter Fisher, the manager of the system's portfolio (4) and an officer of the Federal Reserve Bank of New York, briefed the Committee on developments in the financial and foreign exchange markets, using an array of charts to drive his points home. He also reviewed the operations conducted on behalf of the Committee in the government securities and foreign exchange markets.

The core of the meeting began when Mike Prell, thin, bearded, and intensely devoted to the Fed's mission, presented the staff forecast for the U.S. economy. He began by noting that the economy had grown at about a 3 percent rate in the first half of the year, while potential output (5) was growing at a 2 percent rate. This disparity could turn out to be a problem: If the economy was actually growing faster than its maximum sustainable level, the unemployment rate--which was already low--would tall still further. If so, workers would be increasingly successful in their demands for higher wages, which could raise prices and ignite an upward spiral of inflation.

As Prell continued with his forecast, nothing he said came as any great surprise to us at the table: We had already received the forecast in what is called the Greenbook, a report (with a green cover) that is traditionally delivered to Committee members toward the end of the week before the FOMC meeting. I had had my nose buried in my copy of the Greenbook all weekend, in fact.

The numbers in the Greenbook offer probably the best and most worked-over economic forecast available. The Fed's own staff economists, who are certainly among the best and the brightest forecasters in the land (and have the most extensive resources on which to build their forecasts), put it together. Although each of the governors and Reserve Bank presidents comes to the table with his or her own forecast, the Greenbook plays a dominant role in shaping the Committee's views. For that reason, I began to call the Greenbook the thirteenth member of the FOMC.

Before I joined the Board, I wondered whether the Greenbook was really the staff's independent judgment of economic trends or if it was the Chairman's personal forecast, rubber-stamped by the staff. By the end of my very first meeting--after I had seen Greenspan disagree with the staff's forecast for inflation and productivity growth--I realized it was theirs alone.

As the meeting got under way, the staff and some of the Committee members voiced their concern that the economy was "overheating'--reaching the point of growth and low unemployment that would trigger rising inflation. They based this opinion on the view that unemployment was already below its "full employment" (6) level and might be poised to decline further.

But others at the table disagreed. Certainly the unemployment rate was low. But perhaps it wouldn't spark inflation this time. Could some fundamental economic change be under way that would alter the traditional rules? Perhaps there was a boost in productivity--allowing for faster growth and lower unemployment, without an upward trend in inflation.

Productivity refers to the amount of output produced per hour of work, on average, in the nonfarm business sector of the economy. The higher the level of productivity, the higher the level of output that can be produced (for example, when the economy is operating at full employment). And the faster productivity grows, the higher the maximum sustainable rate of growth of output--that is, the faster output can grow without the threat of overheating and triggering higher inflation.

As was generally the case, the debate moved calmly and thoughtfully from one member to another. No one was pontificating. We were struggling with these issues both individually and as a group.

For his part, the Chairman was especially supportive of the productivity explanation. In particular, he believed that computers and other communications technologies might be giving the economy the ability to grow faster and to operate at higher output levels than ever before--without triggering an increase in inflation. The phrase hadn't been coined yet, certainty not in capital letters--but was this a New Economy?

I knew that Congress and the administration had been raising this very issue. Politicians, in general, liked the idea that a "New Economy" might have arrived, one that allowed the economy to grow faster than ever before. This was good for the country, in their opinion, and also, let's be honest, good for their political careers. Not surprisingly, these politicians wanted the FOMC to believe in the New Economy, too. If we did, then we would be far less inclined to raise interest rates and dim the lights on their party.

I expected this from the politicians. But what surprised me was how strongly the Chairman (whom some members of Congress had frequently criticized for resisting the New Economy concept) was now passionately supporting the idea.

For myself, I was not convinced that there was a New Economy. I saw the economy in a more traditional way, one in...