The MacNeil/Lehrer NewsHour

MR. MacNeil: Good evening. I'm Robert MacNeil in New York.

MR. LEHRER: And I'm Jim Lehrer in Washington. After our summary of the news this Tuesday, we have coverage of a CIA official charged with being a Russian spy, three views of the prospect for higher interest rates, and a Newsmaker interview with the prime minster of Bosnia. NEWS SUMMARY

MR. LEHRER: An official of the Central Intelligence Agency was charged today with spying for the Soviet Union and Russia since 1985. Fifty-two-year-old Aldrich Ames had been head of Soviet counterintelligence at the CIA. His current assignment was in combating international narcotics traffic. He and his wife, Maria, were arrested yesterday and arraigned today in Alexandria, Virginia. They are accused of passing U.S. government secrets to KGBA residents in the Washington area. Court papers said Ames met with Soviet agents in various places around the world and made large deposits of cash to Swiss bank accounts after those meetings. Officials allege he received more than $1.5 million. President Clinton commented on the case at the White House this afternoon.

PRESIDENT CLINTON: I have been kept informed of this investigation for some time now. It is a very serious case. I congratulate the FBI and the CIA for the work they did in cracking it. We will be immediately lodging a protest to the Russian government, and because of the nature of this case there is really nothing more that I can say at this time.

REPORTER: Is this the worst case?

PRESIDENT CLINTON: I don't want to characterize it, but the FBI and the CIA did a very good job on this. They worked on it for a long time, and I can tell you that it is very serious.

MR. LEHRER: White House Press Sec. Dee Dee Myers said the President had ordered his national security adviser, Anthony Lake, and CIA Director James Woolsey to determine what damage was done to U.S. national security. We'll have more on this story right after the News Summary. Robin.

MR. MacNeil: The Chairman of the Federal Reserve told Congress today that higher interest rates may be needed to keep the economic recovery going. Just this month the Fed boosted short-term rates for the first time in five years. But before a House Banking Subcommittee this morning, Alan Greenspan explained why even higher rates might be necessary.

ALAN GREENSPAN, Chairman, Federal Reserve Board: To promote sustainable growth, history suggests that real short-term rates are more likely to have to rise than fall from here. I cannot, however, tell you at this time when any such rise would occur. Looking toward our policy will be to endeavor to select on a continuing basis the monetary instrument settings that will minimize economic instabilities and maximize living standards over time. The outlook as a result of subdued inflation and still low long-term interest rates is the best we have seen in decades.

MR. MacNeil: This afternoon, President Clinton was asked about Chairman Greenspan's remarks.

PRESIDENT CLINTON: Alan Greenspan said that he thought that we had the best conditions for fundamental economic growth in a few decades or more. I think that's quite encouraging and that there was no reason to believe that we had any problem with inflation. And if that's true, if we're going to have steady growth and no inflation, then we ought to keep relatively low interest rates. I think that the people setting the long-term rates should just know what he said, there will be no -- there's no reason to believe there's an inflation problem. I think the main good news for Americans is Mr. Greenspan said that conditions for long-term growth are good. Conditions for low inflation are good. And that's what we believe, and we're going to keep working on it.

MR. MacNeil: More on this story later in the program. In other economic news, the Conference Board reported that consumer confidence fell in February for the first time in three months. The independent research group said it was too early to tell whether American consumers have changed their outlook about the economic recovery. Consumer spending accounts for two-thirds of the nation's economic activity. Federal regulators today voted to cut rates for some cable television services by 7 percent. The action is designed to correct an earlier attempt that backfired, allowing some cable companies to raise rates. The move takes effect in mid-May. Passengers bumped from oversold airline flights can now sue in state courts to recover their financial losses. The Supreme Court todayupheld the lower court ruling allowing such lawsuits. The ruling said passenger lawsuits could not precluded by federal regulation of the airline industry.

MR. LEHRER: Two NASA employees and seven other men were charged today with operating a kickback and bribery scheme at the Johnson Space Center in Houston. The charges followed a 20-month FBI sting operation. Undercover agents posing as executives of a fictitious company offered kickbacks and bribes to people associated with NASA to have their companies' equipment considered for NASA funding. Martin Marietta Corporation has agreed to pay the government $1 million to reimburse the cost of the investigation. Two former employees of that company were among those charged.

MR. MacNeil: Diplomats from the U.S., Western Europe, and Russia met in Bonn, Germany, today in the hopes that extending the Sarajevo cease-fire to other parts of Bosnia. But they stopped short of widening the NATO ultimatum on air strikes beyond the Bosnian capital. The meeting came as the U.N. resumed aid shipments to the former Yugoslav republic. We have a report narrated by Louise Bates of Worldwide Television News.

MS. BATES: The threat of NATO air strikes and Serb reprisals having faded, U.N. relief flights to Sarajevo will resume. Twenty- seven flights landed on Tuesday, and plans were underway to carry supplies to outlying areas of Sarajevo. Senior Western and Russian diplomats were in Bonn to discuss extending the de-militarization of Sarajevo to the rest of Bosnia. Russian Envoy Vitaly Churkin, who convinced the Serbs to disengage their guns around Sarajevo, opposed more NATO ultimatums against the Serbs in other areas.

VITALY CHURKIN: I would be very cautious about it, because, after all, Sarajevo is a very special place, and the configuration, both geographic and political, is very different from some other places in Bosnia-Herzegovina.

MS. BATES: German Foreign Minister Klaus Kinkel meeting U.S. envoys Charles Redman and Steven Oxman said the redeployed Serb guns could be counting other Muslim enclaves. NATO fighter jets in Italy and on carriers in the Adriatic are still on alert. Some U.N. forces said they could be used above Serb troops blocking a U.N. post near Bosnia's border with Croatia. Life is returning to normal in Sarajevo's Serb-held suburb of Grbavica. Unlike the besieged Muslims inside the city, these Serbs have not been shelled or starved, but their relief at the aversion of NATO air strikes and the arrival of friendly Russian soldiers was palpable.

MR. MacNeil: Five Swedish UN peacekeepers were wounded in a mortar attack near the Eastern Bosnian City of Tuzla today. Reuters News Agency quoted a UN source as saying NATO air strikes were ruled out because it couldn't be determined who fired the shell.

MR. LEHRER: That's it for the News Summary tonight. Now it's on to the CIA Russian spy story, the prospects for higher interest rates, and the prime minister of Bosnia. FOCUS - SPY STORY

MR. LEHRER: The worst nightmare of American intelligence became real today. One of their own, an official of the Central Intelligence Agency, was charged with being a Russian spy. FBI agents arrested 52-year-old Aldrich Hazen Ames as he was on his way to work at CIA headquarters in Langley, Virginia, just over the Potomac River from Washington. His wife was also arrested. Both were accused of selling U.S. government secrets to Soviet and Russian agents since 1985 and having received $1.5 million for doing so. We look at the story now with Stuart Taylor, who covers the Justice Department forLegal Times and with former CIA Director Robert Gates. First, Mr. Gates, the President said - - you just heard him in the News Summary say this is a serious case. Is he right about that?

MR. GATES: Absolutely. If the allegations are true that this man worked for the Soviets and Russians inside CIA for that period of time, the potential damage would be great. And I think it would be the first time that we're aware of that they had had someone inside.

MR. LEHRER: All right now. Stuart, you have -- this goes to both of you -- there are a lot of questions that all this raises. And I realize that we may end up with just questions in some of these cases rather than answers, but, Stuart, the Justice Department filed a 40-page statement with this -- for the charges today. And you've looked at this thing in detail and obviously, Mr. Gates, you know some of -- you were -- were you there? They said that they had got on with this case two years ago when you were still Director of Central Intelligence. How did they get on with it?

MR. GATES: The reality is that after Edward Lee Howard volunteered to work for the Soviets after he left the agency, we were aware we had some continuing problems and that weren't explained by Howard, and so an investigation was continued.

MR. LEHRER: Now let me -- for those who don't know about Howard, Howard was a CIA man. He left the CIA. And then he escaped and went back to Mexico and defected to the Soviet Union.

MR. GATES: That's correct.

MR. LEHRER: Okay.

MR. GATES: And we had some continuing problems and so continued a counterintelligence investigation. And over a period of a number of years there was very close cooperation between FBI and CIA, and I hope that this is the outcome of that investigation.

MR. LEHRER: But Ames, according to this, the word that came out today, Stuart, is they got onto Ames because of his expensive -- he bought some expensive cars and expensive house and that sort of thing, is that right? He had a lot of money.

MR. GATES: It's remarkable. If the allegations are true -- and they're very detailed in terms of bank deposits, bank receipts showing that he spent about a million four hundred thousand dollars more than he earned over the last -- since 1985. It's -- he had a $500,000 house, a $40,000 Jaguar, et cetera, on a $69,000 CIA salary. One of the remarkable things is how if this really happened, he could have possibly thought he would get away with it and how, in fact, he could have gotten away with it for so long in living what seems to be a life of conspicuous consumption well beyond his means.

MR. LEHRER: It occurred to me, Mr. Gates, reading that, this guy wasn't very smart if he thought he could get away with that. I mean, does that gel with your recollection of how -- that that's how they got on to him?

MR. GATES: It is certainly a flag in any security or counterintelligence investigation if someone is obviously living beyond their means or beyond the government salary and particularly if there's no knowledge on the part of family money on the part of family money or something like that that something is amiss. On the other hand, until someone brings that to the attention of security or counterintelligence officials, it may not, it may escape notice for a while. It obviously did in this case.

MR. LEHRER: These things were not routinely checked. In other words, the kinds of cars that a CIA person drives is not routinely for this kind of thing, is that right?

MR. GATES: Well, that's correct. Now, there is a security reinvestigation every five years, and that has over time come to include financial matters, particularly in recent years, but --

MR. LEHRER: Does it include a lie detector examination?

MR. GATES: Yes, it does.

MR. LEHRER: So you could assume in this case that Ames, while he -- if this started in 1985, it was, according to the documents, they got on to him two years ago, so he must have undergone one of these reinvestigations in this last, during this time, and that he got through a polygraph. Can we assume that, or should --

MR. GATES: Well, I don't know whether we can or not.

MR. LEHRER: It's likely though. It's possible.

MR. GATES: There would be a good chance of it.

MR. LEHRER: Yeah. Yeah. Okay. What do the records show, Stuart, on when he, how he was recruited?

MR. TAYLOR: The records I've seen don't show it very clearly. They do indicate that during the mid '80s, 1986 in particular, while he was in Washington, part of his job was to be talking to Soviet embassy personnel to be recruiting them, that he began having a lot of alleged meetings with Soviet embassy personnel that were not reported to his superiors, as he's required to do, and started making large cash deposits to local banks, so the inference that the authorities are apparently joined from that is that beginning in the mid '80s he started passing information to the Russians in Washington for money and continued doing so in locations abroad as well as in Washington.

MR. LEHRER: And the irony of -- irony is not the word -- I don't know what the word is -- but his job was to recruit Soviet agents for the American side and in the process he got recruited by them for them, is that correct?

MR. TAYLOR: Yes. And the job -- part of his job was also counterintelligence, which is worrying about who they may be recruiting from our side, but in terms of the damage he did through the espionage, the, the documents filed in court say that he compromised classified CIA operations and classified CIA human assets, i.e., our spies, and I'm told that one of the -- the question was asked by one of the Justice Department officials of another, did he get anyone killed, and the answer was "no comment."

MR. LEHRER: Do you want to add anything to that, Mr. Gates?

MR. GATES: No, I don't think so.

MR. LEHRER: Explain to us what the counterintelligence -- not - - you don't -- not obviously about what Ames did or did not do. What is the counterintelligence operation all about?

MR. GATES: Counterintelligence really has two basic responsibilities. The first is to validate that the agents that we recruit are real, that they are not double agents played against us.

MR. LEHRER: We're not talking about employees of the CIA here.

MR. GATES: No.

MR. LEHRER: We're talking about people that work for somebody else.

MR. GATES: If we were to recruit agents from another country to ensure that they are not being run against us by their intelligence service, to ensure that they are valid, and that their information is valid, the second part of counterintelligence is defensive, and that is to try and make sure that the agency, itself, is not penetrated, that one of our people is not recruited by another intelligence service.

MR. LEHRER: So those who suggest that -- including the President of the United States, and you agreed with him -- that somebody who's involved in Soviet counterintelligence -- in other words, the people with CIA who are working counterintelligence against the Soviets, what Ames was, I mean, this is valuable stuff. This guy would have access to both sides of the, of the pea, would he not?

MR. GATES: If these charges prove to be accurate and true, I think it would be damaging.

MR. LEHRER: So damaging --

MR. GATES: Very damaging.

MR. LEHRER: Damaging in terms of names and assets, correct?

MR. GATES: Yes.

MR. LEHRER: Yeah, yeah. All right. Once they got on to him, Stuart, there was a very elaborate surveillance put on him, was there not?

MR. TAYLOR: Yes. His trash was searched, and they came out with typewriter printer ribbons which they reconstructed the messages and quoting this document statements, communications with foreign, with his handlers, apparently, his alleged handlers, the house was bugged, the telephones were bugged, the house was bugged, this document contains long conversations between him and his wife that purport to be about spies. And they got into his own personal computer at home, including his personal accounting program at home. Apparently, a special report --

MR. LEHRER: How did they do that?

MR. TAYLOR: Apparently, they got a warrant, a special court, foreign intelligence warrant to go into the house when nobody was there and get into the computer generally by -- I don't know how they did it, but my guess is by turning the computer on. They got somebody who knows how to get information out of a computer to copy stuff and leave --

MR. LEHRER: Could you bug a computer to where you could like a telephone from a distant place actually monitor what somebody's doing on it? Can you do that, Mr. Gates?

MR. GATES: No comment.

MR. LEHRER: No comment. But obviously they got it out of there somehow.

MR. TAYLOR: The documents don't make it entirely clear whether they did it the way you or I might get information out of our own computer or by some sophisticated bug technique, although the "no comment" we just heard speaks volumes, I think, about the possibilities of the latter.

MR. LEHRER: All right. But there is a -- the document mentions, and Stuart just quoted the document -- they go before -- there's a special court, is there not? Explain to us what that's all about.

MR. GATES: Back in the late 1970s, the Congress passed a law creating a foreign intelligence surveillance court. And this is a special court of a number of members appointed by the chief justice, and when the government --

MR. LEHRER: These are federal judges.

MR. GATES: Federal judges, federal district judges around the country, and when the FBI or a law enforcement, federal law enforcement agency wants to seek authority to wire tap somebody having to do with foreign intelligence in this kind of case, then they, they make their application for such a warrant to this court.

MR. LEHRER: And there's a hearing. I mean, it's --

MR. GATES: There's a hearing.

MR. LEHRER: -- like a judicial proceeding.

MR. GATES: And what makes it different is that the proceedings are all closed and kept classified.

MR. LEHRER: And does then -- is there any monitoring after that or not? How does it work from then on?

MR. GATES: These, these applications or the continuing efforts are reviewed on a periodic basis, and they're only good for a finite period of time and then have to be renewed in front of the court.

MR. LEHRER: And then was there physical surveillance of, of Ames and his wife as well?

MR. TAYLOR: There was. They were followed in cars among other things. He was watched in landing in South America, getting off the plane. There's one interesting passage sort of mixing suburban married life where he and his wife go to Parents Night at their son's school in Alexandria, Virginia, and on their way home from Parents Night,according to this document, they drove by a site in Washington. They took a detour to something called a signal site to check out whether the Russians had picked up something that Mr. Ames allegedly left for them that day.

MR. LEHRER: Now explain this to us, Mr. Gates. There are signal sites. There's a lot of mention here about dead drops and all of that. Give us -- help us out on the lingo here. What's a signal site and what's a dead drop?

MR. GATES: A dead drop is an agreed site where one or the other will leave information or materials or cash or whatever for the other to pick up. It's a hidden place where you can leave something, leave the scene, and then the other person comes along at a later time and picks it up. It's so that the two people never have to meet, the case officer and the agent never have to meet.

MR. LEHRER: It could be a seat in a theater. It could be --

MR. GATES: You would try and pick a place, I assume -- since I was never one of the case officers, myself -- I'm sure some of my colleagues are amused that I'm answering this question, but you generally try and, and pick a place where there isn't a lot of traffic or where there isn't, someone's not going to come across it by chance and pick it up, so you'll try and seek a place that may be unobtrusive and where you're not likely to be spotted very easily in going to that.

MR. LEHRER: And the signal site is, as I understand it, the way these things work, you might have seven or eight designated dead drops. And the signal site may be a light on in an apartment, you drive by, look at casually, if that light is on in that window, that means it's dead drop seven or dead drop three or whatever. Is that, is that what they're talking about here?

MR. GATES: A signal site basically is to indicate -- it can be a mark or any number of things that will simply indicate that a meeting's desired, or a location for a meeting, that kind of thing.

MR. LEHRER: Yeah, yeah. All right now. The charge is that -- what does it say about his wife? Why is she charged? According to the papers, why was she charged?

MR. TAYLOR: They quote, they quote numerous conversations between the two of them that are alleged to have been part of the conspiracy between them, and they quote him saying that she was accommodating to his desires, and they cite evidence of her depositing cash that he was paid for the espionage. There's no allegation that I've seen in here that she actually joined in the - - in the -- that she actually had secrets that she communicated to the Soviets, but under the law of conspiracy it's not clear that she had to. She helped him, for example, it is alleged she helped him to, to launder the money, to launder the proceeds. And they have some interesting conversations that they quote about conspiratorial activities.

MR. LEHRER: Speaking of the secrets, my reading of this was that not only did -- when they -- they not only monitored him when he was home and all these other things and her as well, they also monitored his work at the CIA and found in his office documents that he shouldn't have had, is that right?

MR. TAYLOR: That's correct. They found copies of documents that were not part, that allegedly were no part of his current activities pertaining to Soviet intelligence, counterintelligence, identities of agents, things like that, and the allegation seems to be that these may have been copies that he'd obtained of documents that he had given earlier to Russian intelligence agents.

MR. LEHRER: If convicted, the maximum penalty is pretty severe, is it not, life imprisonment?

MR. TAYLOR: Life imprisonment, yes. There's no death penalty on the books, I believe, now, but that's serious enough.

MR. LEHRER: Mr. Gates, finally, a lot of people would say, hey, wait a minute, I thought the Cold War was over, what in the world are the Russians doing -- because they up till the day they arrested this guy apparently, at least the allegation is that he was still feeding secrets to the Russians. What do they want now? What's the gain now?

MR. GATES: One of the things that surprises me in all of this is that a number of people are surprised. We've been saying for several years that the Russians continue to spy against it. The Russian military intelligence, the GRU, is, if anything, more active, more aggressive today than they were in the days of the Soviet Union. And their priorities remain the same, primarily technology, but recruiting agents of other intelligence services is always a high priority.

MR. LEHRER: And we're still doing it against them too, is that right?

MR. GATES: It's important for us to know what's going on in Russia.

MR. LEHRER: Mr. Gates, Stuart Taylor, thank you both very much.

MR. MacNeil: Still ahead on the NewsHour, the interest rate puzzle and the prime minister of Bosnia. FOCUS - CONFLICTING INTERESTS?

MR. MacNeil: Next tonight, interest rates and the economy. Earlier this month, the Federal Reserve did something it hadn't done in five years. It raised a key interest rate. The stock market immediately plunged nearly a hundred points, then gradually recovered. In fact, the Fed's decision calmed some experts who thought they detected inflation creeping up, but it upset others who worried that the move might hurt the growth of the economy. Today Fed Chief Alan Greenspan defended the rate hike before a panel of skeptical congressmen.

REP. PAUL KANJORSKI, Chairman, House Banking Subcommittee: What concerns me most and what I hope Chairman Greenspan will explain today is: Why did the Fed raise short-term interest rates when there has been no evidence that inflation is increasing? Like many Americans, I am concerned that the Federal Reserve's action may impede or even end our slow economic recovery.

REP. TOBY ROTH, [R] Wisconsin: Many of us feel that you're taking the punch bowl away as the guests are still taking their coats off. I mean, the economy is just coming out of a slump, and we want a strong economy, and we feel that interest rates, raising interest rates is not the route to take.

ALAN GREENSPAN, Chairman, Federal Reserve Board: If the Federal Reserve Board waits until actual inflation worsens before taking counter measures, it would have waited far too long. At that point, modest corrective steps would no longer be enough to contain emerging economic imbalances and to avoid a build up of inflation expectations and a significant back-up of long-term interest rates. Instead, more wrenching measures would be needed with unavoidable adverse side effects on near-term economic activity. The firming in reserve market pressures was undertaken to preserve and protect the ongoing economic expansion by forestalling a future destabilizing build up of inflationary pressures which, in our judgment, would eventually surface if the level of policy accommodation that prevailed throughout 1993 were continued indefinitely. We viewed our move as low cost insurance.

MR. MacNeil: Now more on interest rates from three experts. Stephen Axilrod was a staffer at the Federal Reserve Board for 34 years. He served as the staff director of the Fed Committee that sets monetary policy. Since 1986, he's been vice chairman of Nikko Securities International, a Japan-based firm. Susan Lee is an economist and author. She's just completed a new book Damaging Delusion on the history of economic policy since the 1960s. James Galbraith is chief of staff of the Joint Economic Committee. He now teaches economics at the Lyndon Johnson School of Public Affairs at the University of Texas in Austin. Mr. Axilrod, can you put in terms I can understand what Mr. Greenspan was just saying, what he means.

MR. AXILROD: I'll give you an interpretation and not a literal translation. I would interpret him as saying that the Fed wants to establish its credibility without any date as an inflation fighter, and that the Fed is going to take a very modest move now, which they do not expect in any way to impede the recovery in order to avoid later excess pressures on prices and wages which might develop particularly if people don't believe in the Fed. If you don't believe the Fed's going to fight inflation, you are more prone to let wages go up, you are more prone to pass prices through, and people are more prone to sanction that because they think the Fed will let it happen. If they believe the Fed won't let it happen, that might be held down.

MR. MacNeil: But the curious thing is that this has fed, instead of calming speculation, this has appeared to feed speculation about, about inflation. It's heated up the speculation that wasn't there.

MR. AXILROD: I don't read the bond market quite that way. And I think to a degree, to a degree, people said, well, maybe inflation will be more than three if he's starting now rather than less than three. That might have happened. But basically, the bond market went through a bout of profit taking because they thought maybe rates won't come down a lot more or secondly, we got into a trade war with Japan, the dollar declined on foreign exchange markets, and that often is associated with a rise in bond yields as foreigners and domestic investors lose confidence.

MR. MacNeil: Just to get some ABC's, why is that associated with bond dealers, because you need to pay a bit more interest on the bonds you sell in order to get foreigners to buy them?

MR. AXILROD: Well, that's right, or if you're a foreigner and have got profits in this bond and you think the dollar is going to go down, you're sort of impelled to take the profits quickly. And if you're a domestic investor and you think that's going to happen, you'd better take them also.

MR. MacNeil: So you think, in short, this was a good move and it's worked so far?

MR. AXILROD: I think it was very timely, and it was about time.

MR. MacNeil: Mr. Galbraith, you're one of the critics who thought the Fed was wrong on February 4th. What do you think now?

MR. GALBRAITH: I think it's wrong now. One of the difficulties of understanding the justification that Chairman Greenspan offered today was that that justification doesn't make any sense. President Clinton had it exactly right a few minutes ago on your program. They had a program which is working reasonably well. Steady growth. No evidence whatever of rising inflation, and dramatic reductions in the budget deficit, those are the elements that we have been told for years would lead to a climate of low and even falling interest rates. And instead, the Federal Reserve turns around on us and starts raising rates. Now as far as bond yields are concerned, I wrote three days after Greenspan's move that this would lead to higher bond rates. And that is exactly what has happened.

MR. MacNeil: So in other words, you don't buy Mr. Axilrod's argument that this is a result of the trade frictions with Japan and profit taking?

MR. GALBRAITH: You can always find 30 things that happened last week that might have caused a movement of the bond market. But in this case we have something that did cause the movement in the bond market, that was predicted to cause it, and that prediction was borne out. So I feel pretty good about that interpretation of the events of the last 10 days.

MR. MacNeil: Ms. Lee, you were a critic of what the Fed did, but from a different perspective. What do you think now three weeks later?

MS. LEE: Well, I think what I thought this summer, and that is there were already signs that inflation was perking up this summer and lots of people were concerned. There were some movements in the commodity interests, people who watch gold -- I don't -- were a little concerned. Monetarists whom I respect very much like Ellen Meltzer at Carnegie-Mellon said, oh, the Fed is too loose, what's going to happen. There were all those kind of rumblings. But now, remember, a year ago Greenspan was talking about zero inflation, zero to two. Three was considered too high. If he wanted to maintain his reputation as an inflation fighter, as Steve has suggested, last summer was the time, and last summer this little tiny bump up would have been appropriate. But he waited too long, the bump up was much too small. The reason the bond markets both long and short are unsettled now is because they're waiting for the other shoe to drop. They said, all right, that was cute, where's the next act? And in this kind of unsettled condition, you're going to get that sort of movement.

MR. MacNeil: So, in other words, he has fed an expectation that there will be more increase?

MS. LEE: Oh, I think exactly right, yes.

MR. MacNeil: And do you agree with that?

MR. AXILROD: Oh, I think it's very likely it increases, will go up, because I happen to think the economy is in rather good shape, and I think it's going to be fairly strong and certainly in the second half of this year.

MR. MacNeil: Just see if we have agreement on that, James Galbraith, you agree that we're going to see the Fed raising, raising short-term rates more the rest of this year?

MR. GALBRAITH: I think that is the current intention. I hope that Congress takes a hard look at this apparent intention and would give the Federal Reserve a very strong signal that it should get back on the team, respect the progress that's been made in bringing down budget deficits so far, and hold interest rates where they are.

MR. MacNeil: I saw the AP today saying many -- many analysts saying the Federal Fund's rate, which is the rate the Fed changed on February 4th from 3 percent to 3 1/4 percent, that it will be 4 1/2 percent by the end of this year. Is that -- would you believe that?

MS. LEE: Well, that doesn't seem unusual to me. The thing that is kind of remarkable is that what Congressperson Roth was saying and what Clinton was saying and now what Mr. Galbraith is saying is exactly the opposite the intention of the Fed, but that is not a member of the administration. It's not supposed to go along with the party. It was supposed to exactly remove the punch bowl when everything is getting going. It's doing precisely what it ought to do, and if it keeps on doing that, of course, they're going to keep bumping up short-term rates.

MR. MacNeil: But just to get some predictions here for a moment, do you think 4 1/2 percent by the end of this year for the Federal Fund's rate is a, is a reasonable prediction?

MS. LEE: I would agree with whatever Steve thinks.

MR. AXILROD: First thing I want to say I don't think they've removed any punch bowl. I don't think they've even made us that significant a move. I think this is a very small, minor move just to establish credibility. I don't think the punch bowl has been budged, because, because the economy is getting better, so you can stand that very little bit of tightening. On the Federal Fund's rate, where it'll be, you know, that's kind of a mugs game to guess that, but my thought is it will be, it will be up some, but my crucial thought in that respect is that I think recovery will begin later this year in Europe and Japan. When that happens, we'll have a pretty strong industrial world. That will be a context in which the Fund's rate ought to go up. If we don't have that recovery and we're on our own here, in that case there will be -- there should be much less pressure to raise the Fund's rate.

MR. MacNeil: Do you think 4 1/2 percent Federal Funds by the end of the year, Mr. Galbraith, is a reasonable projection the way things are going? Whether you approve of it or not, do you think --

MR. GALBRAITH: I wouldn't, I wouldn't rule it out. I would just note here though that the Federal Reserve has been talking about establishing its credibility for well over fourteen, fifteen years. And if they do not think they have credibility now, a quarter point increase in the interest rates isn't going to establish it for them. Further, it's important to realize that when we speak about sending a signal about inflationary expectations, Mr. Greenspan has no instrument that can send that signal without also slowing down the economy, raising unemployment above what it would otherwise be, costing people their jobs, and their livelihood. So this is not a costless process. This is a process which is going to affect ordinary citizens. It's going to raise the adjustable rates on their mortgages. It's going to make it harder for them to buy cars and houses. It's going to make it harder for businesses to invest. We're looking at a policy which is geared at slowing down an economy which is already growing at half the rate that is average for post war recovery, so we're taking an extremely early step to slow economic growth in the context of a recovery that's already slow and that is non-inflationary. It makes no sense.

MR. MacNeil: Do you agree with that, it is going to slow down economic growth and activity?

MS. LEE: I agree that our growth rate is about half what its additional recovery should be. I think that's mostly because the Clinton administration is a very activist administration and has big plans like health care which have unsettled the atmosphere, and I think that the Fed has helped unsettle the atmosphere by creating this uncertainty, how much more, how much farther, when, when, when, but let me say that Mr. Galbraith seems to be sort of back on this old sort of Keynesian notion that little inflation isn't so bad. Well, there's no such thing as a little inflation. A little inflation leads to a lot of inflation, and that's very bad. And working people would rather have, I think, a tiny little hit today than to go what everybody went through in the '70s when we had tremendous inflation and what took a recession to wring it out.

MR. MacNeil: But is he right, this is going to slow down economic activity to the extent it will raise mortgage rates, discourage some people from changing or buying homes, it will, it will have, result in somewhat more unemployment.

MR. AXILROD: If we can abstract a bit from the 6 percent growth in the 4th quarter, I would say, no, it's not going to slow the economy down as compared with what it had been doing since the bottom of this recession, and I would -- and I would take this as a simply, actually a down payment on credibility because if the, if we get much closer, much lower unemployment rates, which I devoutly hope we'll get, and much higher plant capacity use, which I also hope we get, then we're, then we're into the period where price and wage pressures might traditionally arise. And at that point the Fed will have to have done more to establish real credibility, so I regard what he's done as a down payment.

MR. MacNeil: Mr. Galbraith, you say no -- absolutely no evidence whatsoever of rising inflation. No evidence at all?

MR. GALBRAITH: Well, you know, food prices which have not risen for four years went up a little bit last year at the same time prices for manufactured goods went down. So yes, no evidence of rising inflation is an entirely correct assessment of the present situation, and, indeed, if you read Chairman Greenspan's statement today, he doesn't offer any evidence of rising inflation. He offers vague statements about some people's expectations that inflation might rise in the future. And when he first came out with this on the floor, Sen. Sarbanes made the entirely proper comment that that's the kind of reasoning that can justify any action at all. Why not, after all, cut interest rates in order to fight an expected increase in unemployment? You can justify that on exactly the same grounds which is to say there are no grounds whatever.

MR. MacNeil: You offered earlier -- just spell out your evidence that you see signs of inflationary pressures.

MS. LEE: Well, inflation really starts at the very basic level in an economy. And that would be commodities, prices of raw materials. And those indices have been going up. Now, you can -- there always is a story. You can say, well, the price of lumber is going up, because all the people are rebuilding, because -- and for each little tiny thing in the index you can say, well, this is because, this is because, this is because, but overall, commodities are going up. The price of gold, which people --

MR. MacNeil: Oil has not gone up.

MS. LEE: No, oil, and, in fact, that's one of the astonishing things. With the low price of oil and low interest rates and low inflation, why the recovery hasn't been better, and that's where I think the danger is, and Steve may be discounting that this kind of bump up is going to slow the economy more, because we had all these things in place for a really dynamite recovery, and we haven't gotten it.

MR. MacNeil: What evidence of inflationary pressure do you see, real hard evidence, or is it all on the expectation because traditionally if the economy starts expanding, there's more demand for goods and services and it drives prices up?

MR. AXILROD: Well, it's not there's more demand for goods and services per se but there's more demand at a time when you have less resources available, so to speak, to meet that demand. We're not quite there yet, and what I interpret Mr. Greenspan as saying, he wants to be sure that when we get toward that point, people will not -- in the process of getting very close, you get very tempted to raise prices and raise wages, that they will not do that, or at least to the extent they otherwise would. But my gut feeling, if you don't mind having a gut feeling here, my gut feeling is it's getting a little easier for certain businesses just to pass along prices increases, it's getting a little easier to make them stick. The housing market has bottomed even in certain very bad areas, maybe not -- and so you're, you're at a point where it's sort of like that I would say.

MR. MacNeil: Uh --

MR. GALBRAITH: That gut feeling is not borne out by an examination of what's happened to the prices of manufactured goods since the early part of 1993. Those prices have, in fact, been falling, so that there -- we're making -- I think Steve correctly says policy is being made on the basis of the gut feelings, but policy does not come without consequences. And in this case, one of the consequences that Congress in particular has to bear in mind, this policy will act directly to increase the budget deficit by raising the interest it's paid on the national debt and thereby undermine the enormous progress that Congress made last year when it bit the bullet on the budget and passed the President's deficit reduction program. In this sense, the Federal Reserve is now setting policy as Ms. Lee noted independently of the administration, and you've got a situation where the car now has two drivers once again. That's a very dangerous situation for the American economy to be in.

MR. MacNeil: Ms. Lee.

MS. LEE: Gosh, I don't think a car should have two drivers, but I think there should be two cars, and I think that's what we are supposed to have. We have an administration and we have a Federal Reserve. The Federal Reserve, again, is supposed to take away the punch bowl, because if you don't -- you wait until everybody's somewhat drunk, it's just as bad as if they're terribly drunk, and you can't -- it goes back to what you're saying about expectations, gut feeling. If people expect inflation, they will act in anticipation of it, and we will get inflation.

MR. MacNeil: Well, thank you all three, Ms. Lee, Mr. Galbraith, Mr. Axilrod. NEWSMAKER

MR. LEHRER: Now the Bosnia story. Margaret Warner has more. Margaret.

MS. WARNER: Jim, there's been a lot of diplomatic activity in Europe and in Washington today on the Bosnia issue, and at the center of it is Bosnia's prime minister, Haris Silajdzic. Yesterday he met with Sec. of State Christopher and tonight he joins us. Mr. Prime Minister, thanks for joining us.

HARIS SILAJDZIC, Prime Minister, Bosnia: My pleasure.

MS. WARNER: Let's start with the situation on the ground. Has the NATO ultimatum worked out as you hoped?

PRIME MINISTER SILAJDZIC: Well, there are a few guns left around Sarajevo not impounded, not under control. But the problem is that the siege of Sarajevo remains. The electricity, gas, water, everything's controlled by the aggressive Serbian forces, and we are afraid of the situation being frozen and Sarajevo becoming a ghetto, but of course, those in Sarajevo are very, very happy not to have shells anymore.

MS. WARNER: And is there anything in the short-term sense that the West could do to address that problem that you just mentioned, that the Serbs still control all utilities and so on?

PRIME MINISTER SILAJDZIC: Well, the only lasting thing is a comprehensive peace agreement. Sarajevo cannot be an island of peace while, while the war rages in the rest of Bosnia-Herzegovina. So the comprehensive agreement, peace agreement, is, is the real solution.

MS. WARNER: Now, as you know, the American, European, and Russian diplomats met in Bonn today to talk about possibly extending this truce idea to other -- some of the other seven supposedly safe havens for Bosnians throughout Bosnia, and they decided to do so but with one distinct difference, which would be no ultimatum. Do you think that would work?

PRIME MINISTER SILAJDZIC: Well, I don't think so. I don't think so. No. 1, I don't think it will work the way Sarajevo worked, and I also think that it is a very, very dangerous thing to create ghettos. That's why I am talking about a comprehensive and, of course, just agreement, a just, comprehensive settlement, because we can create a number of isolated areas in Bosnia and forget about the rest, and then have the status quo for a number of years there without being able to create a viable Bosnia once again, a survivable Bosnia, have our people back. The most important thing is to have our refugees back, right of return.

MS. WARNER: So just so I understand, what you're saying is it really doesn't bother you that the West is not going to try to extend this model to other Bosnian cities?

PRIME MINISTER SILAJDZIC: Well, we are not there to judge that. We were asking for one thing for two years now, let us defend ourselves. Well, it did not happen, so the aggression was facilitated, and we have a situation now we have we must deal with in the best way we can. And the best way is to have a comprehensive agreement, a just agreement. And just agreement means the return of those expelled from their homes back to their homes.

MS. WARNER: All right. Let's look at the prospects for an agreement. What has this ultimatum, this NATO ultimatum done to progress at the peace table? How has it changed the equation?

PRIME MINISTER SILAJDZIC: Well, it, I think it has broken a psychological barrier. There is a message sent to the aggressor Serb forces that they are not going to be able indefinitely to kill innocent civilians. And on our side there is, there is a realization that peace there is possible with the help from the democracies of the world.

MS. WARNER: One of the arguments made here in the United States against setting up this ultimatum was that if your government felt you had NATO on your side you would become less conciliatory and not more at the peace table, but you would want more. Anything to that?

PRIME MINISTER SILAJDZIC: Well, yes, what can I say? So the thing is not to do anything at all. That's the alternative. That's like saying let's not do anything there, let's not try and do something because the Bosnians will become encouraged and so on, so this is unprojected policy.

MS. WARNER: But I'm asking if it has come to pass or if, in fact, you feel your government is pursuing peace just as -- at the peace table just as aggressively as you were before.

PRIME MINISTER SILAJDZIC: Well, our government is interested in peace much more than any other side in this war because we do not have the arms, because our people suffer most, because we are in a sandwich between two hostile forces, because it has become increasingly difficult to feed the population of Bosnia- Herzegovina. We have now people dying of hunger in Bosnia. That is a fact, a very sad fact. We have gray-haired children in towns of Vitez and other towns in Bosnia, so that is why we need peace, but we need a just peace there, so this is difference.

MS. WARNER: Of course, you've been meeting with American officials. How do you see the American involvement here? Do you think the Clinton administration has a plan now, a strategy for getting an agreement?

PRIME MINISTER SILAJDZIC: It depends, of course, a lot on the sides around the table. There is a, I believe, a general plan there, and the general plan is to end the suffering of people there as soon as possible. Now, we have problems there that the aggressors, the perpetrators, are not convinced that they must return the territory seized by force. Someone has to convince them that they cannot keep their gains by force. They have to leave the territory they took by force. They have to, to enable people to go back to their homes and so on. So this can be done in my mind only by credible threat of use of force.

MS. WARNER: But just so I understand your government's negotiating position, have you accepted the notion of partitioning Bosnia along ethnic lines.

PRIME MINISTER SILAJDZIC: Unfortunately, we had to do it. In August, we accepted the reorganization of our country on ethnic lines, which is for the first time in Bosnian history. The population is so mixed it's a multicultural, multiethnic society, always has been. Now because of the aggressions, unchecked aggression, and because of the indifference of the International Community until this ultimatum, we had to accept in order to stop the suffering of the people. Now we dislike that. It must be clear we do not agree with that in our hearts, but then we had to accept that, the ethnic division of something that has never been divided on ethnic lines, believe it's cutting through live flesh, and that flesh is bleeding right to the bone.

MS. WARNER: Of course, there are both Americans and Europeans who say that it's not only wrong to have this happen but that it's just the prescription for more ethnic conflict. I mean, Maggie Thatcher says this, some American columnists say this. Are the plans you're looking at -- is it possible to create a viable Bosnian state, or are they right? Is it just postponing another war two or three years down the road?

PRIME MINISTER SILAJDZIC: Well, that's a very good question. I think Bosnia in a way is being Europeanized. It means Europe now is nation states only. But on the other hand, Bosnia is a very special case, it reflects, it's a prism in which everything reflects not only the present but future conflicts on civilizational lines, on cultural lines, and so on. So we believe that whatever is lost in Bosnia, is lost for the International Community as a whole, it's a dangerous precedent, very dangerous precedent, No. 1 that aggression is rewarded, and No. 2, saying that people even in the -- even in the 20th century all the technology we have are not able to come and live together there. We believe that Bosnia is needed by the world and places like Bosnia. Why? Because of this technology is bringing people together fast, faster than human beings can understand and solve it, it's too far -- it's chips against human beings. It's airplanes against human beings. So people are brought together. They cannot, they cannot solve those problems of acculturation so fast, and then there are conflicts. Bosnia is the place where it's proven that people can live together, different cultures, where America is a place, of course, but there in Europe there is only one place.

MS. WARNER: Now you're looking at a plan in which, in fact, at least the Serbs will not be part of Bosnia.

PRIME MINISTER SILAJDZIC: No, they will be part of Bosnia, of course. The sovereignty and total integrity of Bosnia is there. The problem is that Bosnia has been looked up and is a territory up for grabs not as a state. This must change. This must change.

MS. WARNER: Let me ask you about an idea being advanced by the American administration which is that the Bosnian -- Bosnian government, the area controlled by Bosnia and the Croatian part of Bosnia would come together in some kind of confederation. Is that workable after all the fighting that you and the Croats have engaged in?

PRIME MINISTER SILAJDZIC: It is workable. It's very difficult. The wounds are deep and fresh still but it is workable because we believe that the Croats in Bosnia want to live with their neighbors. They've lived for hundreds of years there. Many Croats in Croatia proper would like to see that happen too, and we are trying to create something that's not ethnically divided, no national territories. Bosnia is for all the Bosnians. Once we try to make a national territory, draw lines, there is conflict.

MS. WARNER: Forgive me for being skeptical but you and the Croatians were in an alliance of sorts a couple of years ago and yet, then they came and the Croatians came to take territory away from you. Are you confident that this is a deal that could stick, that they wouldn't turn around and, in your view, double cross you again?

PRIME MINISTER SILAJDZIC: They are guaranteed that. No. 1, that we believe and we know that the Croats, the Croat citizens in the republic of Croatia want that, they support that, and No. 2, that is where we need international guarantees to offset fears of both sides. There are fears, and fears are real.

MS. WARNER: And before we leave then tell me what more would be expected from the United States if you got this kind of a deal?

PRIME MINISTER SILAJDZIC: We need implementation.

MS. WARNER: Meaning American peacekeepers and others.

PRIME MINISTER SILAJDZIC: Yes. That is right. We need American leadership to continue in this conflict. The world is still looking to America for leadership. We need leadership in the world more than ever. This are very difficult times. We have difficult times ahead. We need the leadership in this ever small world more than ever.

MS. WARNER: And how messy and how dangerous an operation would that be to police this?

PRIME MINISTER SILAJDZIC: It depends on the agreement, but I believe that the presence of -- they are talking about 50,000 NATO troops there would be enough, would be enough to keep peace without many problems.

MS. WARNER: Well, that's all the time we have. Thank you, Mr. Prime Minister.

PRIME MINISTER SILAJDZIC: Thank you. RECAP

MR. MacNeil: Again, the major stories of this Tuesday, a senior CIA official and his wife were arrested on charges of spying for the former Soviet Union and then Russia. President Clinton called the case "very serious" and said the U.S. had filed a protest with the Russian government. And the chairman of the Federal Reserve said higher short-term interest rates may be needed to keep the economic recovery going. Good night, Jim.

MR. LEHRER: Good night, Robin. We'll see you tomorrow night with an interview with the leader of the Bosnian Serbs. I'm Jim Lehrer. Thank you, and good night.