 A quick question. What's inflation? Inflation, I don't know, is a bad thing. Inflation is arising of prices. And prices keep going up. Everything is going up. How about recession? Recession? Lots of people out of work. The people stop buying stuff. Recession? A slap in the economy. One more. What's the Federal Reserve system? Federal Reserve system? That's something to do with the government. They're trying to control the amount of money that's out in the economy. They probably try to help stop inflation and stuff like that. That's exactly right. The Fed does lots of things. But its most important job is to try and keep the economy growing by fighting inflation. That means keeping prices stable. For example, say you buy a CD today for $14. Next year, the same CD costs $16. Maybe the group is more popular, or the metal in the disc is suddenly scarce. That's not uncommon. A single item can go up or down in price for many reasons. But what if the price of the CD jumped to $20 or $50? Not because of a change in supply or demand, but because all prices were going up. That's inflation. Now if your income is going up just as fast, it's no big deal. But that isn't usually the case. More than that, inflation makes business and personal decisions extremely difficult. Companies can't plan for the future. They don't build new factories. They don't hire new workers. The entire economy is distorted. There are a lot of different causes of inflation, but one of the most important is too much money. Here's what I mean. Pardon my reach. We gave this high school class some money to spend. $2.50 each. And something to bid on. Three dozen fresh bagels. 15, 15! That's getting 20. 25. 25, 25. Back there for 25. Guy in the blue. Another one. Their goal? To buy as many bagels as possible. 25, 30. He says she's hungry. 35, you've got it. All right. What about this one? 10 cents. She says 25. 35. 30 cents. 30 cents. She's got it. 50 cents. 50 cents. You got yourself a bagel. 50 cents. The average price of a bagel, 50 cents. Then we started over. But this time, each student had $5. Twice as much as before. Okay. What about this one? 50 cents. He says 80. 80. $1. The lady in front of the blue says $1. Yes, the lady with the boopy do. All right. One more. $1. A dollar 10. A dollar how much? $1. $1. $1. $1. $1. $1. $1. $1. $1. $1. $1. $1. $1. $1. $1. This time prices were twice as high. And as we kept increasing the money supply, the price of a bagel went out of sight. $5, $5. Whoa, look at her. She's got $5 here. Can you catch it? It's the old cliche. Too much money chasing the same amount of goods. There were the same number of bagels, but more money. So prices were higher. Because many people and companies are hurt badly by inflation, governments aim for stable prices. Think of all the transactions going on every day. All the people buying and selling things. That's the overall economy. You might picture it as kind of a vehicle going down the road. All those millions of transactions require money. If there's not enough money, the whole system, the economy, may jerk along too slowly. But with the right amount of money, things run smoothly and prices remain fairly stable. Okay, so how does the amount of money change? That's where the Federal Reserve System comes in. As the country's central bank, the Fed manages monetary policy, meaning it actually changes the size of the nation's money supply to meet a goal that sounds simple, a growing economy with stable prices. But it's not always easy to achieve. The best way to explain it is to look at how inflation works in the real world. Let's go back in time, way back to 1979. It's March 1979. Magic Johnson and Larry Bird meet in the finals of the NCAA basketball tournament. The latest fad? Pet rocks, which do absolutely nothing. Meanwhile, gas prices are climbing. So is the price of food and just about everything else. Everyone's talking about inflation. Even the comedians on Saturday Night Live. Inflation is our friend. For example, consider this. In the year 2000, if current trends continue, the average blue color annual wage in this country will be $568,000. But inflation is no joke. In one way or another, almost everyone is affected. I really hate it because you pay so much for so little. We've cut down on food. It's positively discouraging. This is NBC Nightly News. To most Americans, inflation is public enemy number one. Good evening. Prices in the United States during the first three months of 1979 went up at an annual rate of 13%. The question is how long will this go on? Inflation running out of control. The answer? Probably for years. There's nothing in sight to stop it. So while Magic Johnson was winning a national championship, Paul Volcker was worried about inflation. You cannot build economic growth. You cannot build prosperity. You can't build full employment on a currency that is inflating, a currency that people don't have some confidence in. In 1979, Volcker was appointed chairman of the Federal Reserve Board of Governors. The Fed tries to avoid inflation because it causes many problems. Businesses don't know where prices are headed and can't plan for the future. Individuals tend to spend their money faster before it loses even more value. And they tend to save less. The rate of saving in the U.S. is the lowest of any major country in the Western world because saving money is a losing proposition. In 1979, people are putting less money in the bank and are spending money on items like gold and jewelry, which tend to hold their value. The big loser is the overall economy. If you're going to build more factories, if you're going to buy some machines, you have to have some savings. But there's no incentive to save. If you see your savings growing up in smoke, so to speak, because prices are rising. What's the use of saving $10 this year if it's going to cost you $15 next year for what you didn't buy this year? So inflation harms the economy in general. And it harms individuals. Runaway inflation really produces people in poverty. Nancy Teeters was sworn in as a governor of the Federal Reserve Board just as inflation was picking up steam. I remember in that period of time, we bought a car, I guess, in 79. We hadn't bought one since sometime in the 60s. And it was real sticker shock. I mean, the same car was going to cost me like five times as much. It took me six months to get over it. One fear was that inflation could spiral into hyperinflation, as it had in Argentina when the government kept printing more and more currency. At one point, Argentina's inflation got so out of control that consumers rioted against rising prices. October, 1979, Mother Teresa is awarded the Nobel Peace Prize for her work with the poor. And the Federal Open Market Committee declares war against inflation. The FOMC includes the seven governors of the Federal Reserve Board and presidents of the 12 Federal Reserve banks around the country. The committee meets eight times a year to set goals for the nation's money supply. What they decide affects everyone in the country. In 1979, they had to do something. The alternative of not having done anything, we were pretty sure would be a severe depression. And we wanted to avoid that at all costs. Bob Black was president of the Federal Reserve Bank of Richmond. He and the rest of the FOMC knew there was only one way to get rid of inflation. The choice was to slow the growth in the money supply as a means of easing inflation and trying to set the basis for long-run economic growth. So what the Federal Reserve does fundamentally is control the money supply. And we finally reached the point where we said, look, we're just not going to permit an increase in money supply to support this inflation. That sounds easy. Just issue less money. But there's more to it. First off, money isn't just this green stuff. Paper currency and coins make up less than a third of all the money in circulation. Money also includes all the deposits we hold in checking accounts. These are simply electronic entries that exist on a bank's computer. But they're money just the same. Basically, anything you can spend, whether by writing a check or taking out your wallet, is defined as money. The Fed can adjust the money supply by injecting money into the system electronically or by withdrawing money from the economy. Think of it, the Federal Reserve has the ability to create money and make it disappear. What's most important is what happens as a result. Anytime the supply of money is altered, the effects are felt throughout the economy. If the money supply is growing rapidly, interest rates tend to go down, at least in the short run. It's a simple matter of supply and demand. When banks have more money available to lend, they don't charge as much interest. In turn, lower interest rates encourage consumers to borrow money. And when people have more money, they're usually willing to spend more for products. Prices tend to go up. That means inflation and all the problems that come with it. Now look at the other side of it. When there's too little money around, the scarcity of money means people will have to pay more to borrow it. Interest rates tend to go up. Because borrowing is more expensive, consumers are less likely to take out loans. In general, people have fewer dollars to buy things with and businesses can't raise their prices. Over time, inflation tends to slow down or stop altogether. That's the power of monetary policy. So when inflation gets out of hand, the Fed tries to slow the growth of the money supply. But as you saw, that can mean higher interest rates, at least in the short term, which brings us back to our story. It's December, 1980. There's the launching of a new cable channel. It's called Music Television, MTV. At the same time, the spaceship Voyager sends back pictures of the planet Saturn. Meanwhile, the U.S. economy is still in trouble. The prime lending rate went to 21.5% today. Before this week, it had never in American history been above 20. The new rate hurts. The auto industries and housing industries, especially most of their customers must borrow to buy. The Fed has restricted the growth of the money supply. And interest rates are rising rapidly. One effect, fewer people can afford to borrow money to buy a new car. You can't even buy an automobile. The interest rates are so high on everything. The price of the car is bad enough, but the interest rate is ridiculous. High interest rates also mean fewer people can buy new homes. As a result, the housing industry is in the pits. And throughout the country, people are blaming the Federal Reserve. Thirty years with my wife and three kids, and I got to worry about what folks are going to do. I like to resign parts to resign themselves. The Fed governors receive hundreds of two by fours in the mail, a symbol of protest from the construction industry. Meanwhile, there's a demonstration outside the Federal Reserve building in Washington. The Fed, and especially Chairman Paul Volcker, are under attack. There was a cement company that used to put ads, full page ads in the Wall Street Journal and skull and crossbones under my name or picture or whatever. And it kind of rankled a bit, but I do think there was a feeling in the country then that there was something of an emergency that had to be dealt with. It had to be dealt with by forceful action and a kind of common sense reaction that there'd be a little pain in the process. And that's what got you through. It's October, 1982. The space shuttle Columbia takes off for an important mission. It will release a satellite into permanent orbit. Back on Earth, the latest rage is called break dancing. Meanwhile, inflation and high interest rates have taken their toll on the economy. Companies are borrowing less and investing in fewer new plants, and existing plants are being shut down. Once you begin to decrease the rate of real growth, you begin to cross the rate unemployment rise. And you know that, and that's why it's a difficult decision to make. I mean, it's the sort of thing that wakes you up when you worry about it at three o'clock in the morning because real people are getting hurt. November, 1982. The American economy is in a recession. 12 million people are out of work. Almost half a million more Americans lost their jobs last month as unemployment rose four tenths of a percent up to 10.8. I've been off since June. Late off since June 21st. No money. You know, no work. Rising unemployment has one side effect because people have less money to spend. Businesses can't raise prices as quickly. One eventual result, lower inflation. The inflation numbers for 1983 came out and they were the lowest that they have been since 1971-72. 3.8 percent. That's down for more than 12 percent in 1980. July, 1984. The new fashion torn sweatshirts inspired by the movie Flash Dance. Meanwhile, Americans are going back to work and the unemployment rate is falling fast. In May the rate stood at seven and a half percent. Today the June rate was announced and it's a big drop to 7.1 percent. At the same time inflation seems under control. Prices which were going up at more than 13 percent a year are rising at 4 percent. The fight against inflation has apparently been won. Once we got the inflation rate down, we had the longest expansion in peacetime and recorded American history. So instead of kind of stumbling from one recession to another, I think it is true in a broad sense that we laid the basis for a long period of expansion. So when the Federal Reserve makes monetary policy, its decisions affect all of us in one way or another. Those decisions originate from all over the country. Remember the Federal Open Market Committee, the FOMC? It has the final word on monetary policy and it includes the presidents of the reserve banks located around the country. It's grassroots democracy in action because each of the presidents represents his or her district. Here's what I mean. For Bob McTeer, this is how the day begins with an hour of exercise to get ready for the work ahead. McTeer is president of the Federal Reserve Bank of Dallas. His district includes all of Texas and stretches east into Louisiana, west into New Mexico. It includes cities that reach to the sky, wide open spaces, and everything in between. This is home for nearly 20 million people. Their economic well-being is a priority of the Dallas Fed. We have our eyes open and our ears open and we use all the information that we can get in making monetary policy. That information comes partly from a staff of economic researchers. Well what about drilling activity in Texas? Drilling activity is down. They examine the local economy and report to Bob McTeer. Sure nice to have you here today. Thank you. But the president's job goes far beyond looking at numbers. It also requires getting out in the community, always listening to what people are saying about the regional economy. About two weeks ago we've stopped to pick up. All the economists in the world and all the statistics in the world are no substitute for hands-on communication. The rubber meets the road out there where people are buying McDonald's hamburgers and where people are getting their tires rotated and where people are going into the malls and we need we need to know firsthand how that's going. Each reserve bank is governed by a board of directors. The board has nine members including local bankers and business and community leaders. They meet once a month to discuss the local economy. That people are not spending, they're not hiring and Houston appears to be To sum it up, I would say that the El Paso area continues to be slightly optimistic. The Dallas board includes members like J.B. Cooper, a cattle rancher, investors C.C. Smith, and Milton Carroll, owner of a small business. Milton Carroll's company is called Instrument Products. It makes precision tools for the oil industry. The ups and downs of running a small business give Milton Carroll a unique perspective on the regional economy. This is the real deal. This is where it's at. I come here every day and I engage the economy in my business right here through talking to my suppliers and my customers and activity that's going on in my business and seeing other small businesses around me. The information that's that's printed in the paper about the economy etc etc that has less relevance to me than what's happening every day. At the monthly board meeting, Milton Carroll's concerns are passed directly to Bob McTeer. Those are just a couple things that in my judgment could affect future expansion. And from there to the Federal Open Market Committee in Washington, meaning he and other board members play a role in shaping some of the most important economic decisions in our country. There are 11 other Fed presidents who perform the same job as Bob McTeer. Their goals are identical. We're all working for general prosperity. We're all working for economic growth and we're all working for a stable price environment, a stable financial environment that is conducive to growth. So there are no different goals from one reserve district to another or from one region to another but there are different circumstances. Of course the Fed doesn't have absolute control of the nation's economy, just the monetary policy side of the equation. The President and Congress manage fiscal policy, decisions about taxing and governmental spending that also have major effects on economic performance. Still the Fed has a huge influence on matters like inflation and interest rates and that influence extends beyond the borders of the United States. The global economy is now so interconnected that decisions made in the U.S. are felt in every other country around the world. The Fed's methods have changed over time to take advantage of the latest technology in computers and electronics but when it comes to monetary policy its mission remains the same, to aim for stable prices, full employment and a growing economy. I'm Bobby Rivers, thanks for watching.