I think the most important thing is the tendency for expectations to be backward looking and to be adjusted slowly so that it takes time before any expectation is altered by the impact of an event. (p. 137)

The answer must depend on which cycles we are talking about. If we are discussing the U.S. Depression in the 1930s or the depression in Indonesia today or Mexico five years ago, I would say that technology shocks are a minor part of the picture. On the other hand, if we are talking about the fluctuations in the postwar United States the relative importance of technology and other real shocks is much larger, something like 80% of the story. (p. 63)

Calibration is less optimistic about what your theory can accomplish because you'd only use it if you didn't fully trust your entire model, meaning that you think your model is partly misspecified or incompletely specified, or if you trusted someone else's model and data set more than your own. (p. 313)

I wrote my thesis on the Federal Reserve, again sort of by accident…. I had to write a senior thesis, and in my procrastinating way…. I sat around, floundering around, not knowing quite what to write about, and I didn't do anything for that whole semester. I don't know where I got this idea of the Federal Reserve, but it seemed simpler and more straightforward to some degree than other things and, as I say, I was intrigued by money and banking. (p. 166)

Our subject had myriads of challenging open problems—problems that mathematical techniques could throw light on, and also close out. I once described this as being like fishing in a virgin Canadian lake. You threw in your hook and out came theorem after theorem. (p. 154)

I started out with a hypothesis that is similar to that which underlies the distinction between real and nominal interest rates. How do people adjust their expectations? How do they decide what fraction of their income to spend? I developed the hypothesis along these lines. I put it in a form in which it could be tested and I derived its implications…. As you know, the original pressure for the analysis was the apparent inconsistency between two bodies of data: long time-series data and cross-sectional budget data on consumption and income…. [t]he permanent income hypothesis seemed to me a much more elegant way to rationalize that difference. And it had, as special cases, almost all of the alternative hypotheses, so it was a consolidation of a lot of empirical evidence as well as theoretical analysis. (p. 127)

I believe that you have a more secure basis if, instead of relying on extremely sophisticated analysis of a small body of data, you rely on cruder analysis of a much broader and wider body of data, which will include widely different circumstances. The natural experiments that come up over a wide range provide a source of evidence that is stronger and more reliable than any single very limited body of data. (p. 133)

I was interviewing Pentti Kouri, then a job-seeking new MIT Ph.D., in my office in Chicago. Kouri didn't want to waste our half hour talking about Chicago winters, so he asked me: “How would you price assets in the following economy?” and then went on to describe the model that is treated in my paper. I went to the blackboard and began writing Bellman equations and clearing markets, and the fact that you didn't need to know the value function to get a very tractable functional equation for prices fell right out in a few minutes. Kouri was not interested in collaborating, so I wrote up these results and others myself. (p. 65)

From the moment Burns got into the Fed, I think politics played a great role in what happened. So far as Nixon was concerned, there is no doubt, as I know from personal experience. I had a session with Nixon sometime in 1970—I think it was 1970, might have been 1971—in which he wanted me to urge Arthur to increase the money supply more rapidly [laughter] and I said to the President, “Do you really want to do that? The only effect of that will be to leave you with a larger inflation if you do get reelected.” And he said, “Well, we'll worry about that after we get reelected.” (p. 116)

It always seemed to me that there is a kind of commonsense view that inflation is too much money chasing too few goods. You could oversimplify it and say that inflation is just a monetary phenomenon. There are decades, hundreds of years, of economic thinking relating the money supply to inflation, and people to some extent have that in their bones. So I think we could explain what we had to do to stop inflation better that way than simply by saying that we've got to raise interest rates. It was also true that we had no other good benchmark for how much to raise interest rates in the midst of a volatile inflationary situation.

At least as important was the idea to discipline ourselves. People in the Federal Reserve don't like to raise interest rates. So the danger is you're always too little too late. I think that would apply to the current situation [April 2000]. So, when inflation really had the upper hand, it was, I think, very important to put something out there so you could discipline yourself. For that kind of a commitment, you've got to know what's at stake, and it does make some broad sense if you have that much inflation. (pp. 178–179)

What really propelled me to make the change was when we raised the discount rate for the second time, when I was first down there. The vote was 4–3. I thought it was a reasonably strong move and we'd get a favorable reaction in the market, but we didn't. The response was, “Well, gee, the Federal Reserve is behind the curve anyway, the vote was 4–3, and that's the last increase of the discount rate we'll see.” So the market reacted very badly, which surprised me. I guess I was a little naïve. I remember very clearly, I didn't bend over backwards to try to twist the arms of the three people who voted the other way. I knew I had four votes. If we had to increase the discount rate again, we'd have another 4–3 vote. But that's not the way the market read it. Then I realized that we had this credibility problem worse than I thought. That got me off and really thinking operationally about the other approach. But when it was sprung on them, everybody was very much in favor, even those who were voting against the increases in interest rates. (pp. 178–179)

Then in October [1982], or whenever it was, the money supply (by some measures) was increasing again rather rapidly. We had a tough explanation to make, but I thought we had come to the point that we were getting boxed in by money supply data that was, in any event, strongly distorted by regulatory changes and bank behavior. We came to the conclusion that it was not very reliable to put so much weight on the money supply any more, so we backed off that approach. (p. 183)