Lawrence Kudlow: Reagan + Friedman + Keynes: We Need All the Help We Can Get.
Back in early 1981, when I went to Washington to work for President Reagan, one of the architects of supply-side economics, Columbia University's Robert Mundell, visited my OMB budget-bureau office inside the White House complex. At the time, we were suffering from double-digit inflation, sky-high interest rates, a long economic downturn and a near 15-year bear market in stocks.
So I asked Prof. Mundell, who later won a Nobel Prize in economics, whether Reagan's supply-side tax cuts would be sufficient to cure the economy. The professor answered that during periods of crisis, sometimes you have to be a supply-sider (tax rates), sometimes a monetarist (Fed money supply) and sometimes a Keynesian (federal deficits).
I've never forgotten that advice. Mundell was saying: Choose the best policies as put forth by the great economic philosophers without being too rigid.
Of course, John Maynard Keynes was a deficit spender during the Depression. Milton Friedman warned of printing too much or too little money. And Mundell, along with Art Laffer, Jack Kemp and others, revived the importance of reducing high marginal tax rates to reward work, investment and risk. The idea was to make each of these activities pay more after tax, and in the process boost asset values across the board. This incentive model of economic growth was used effectively by President John F. Kennedy and the great 1920s Treasury man, Andrew Mellon.
During the 1980s, Reagan enacted Mundell's three-legged approach. He slashed tax rates on the supply-side and was not afraid to run budget deficits in the Keynesian mold. At the same time, Reagan gave Paul Volcker carte blanche to practice the tough-minded monetarism that curbed excess money and vanquished inflation. This eclectic policy mix reignited economic growth, and it ushered in a near three-decade prosperity boom that revived free-market capitalism.
Today, however, the economic naysayers are ignoring the advice of Mundell. Looking at our financial crisis, with its deflationary sweep from stock markets to home prices to energy, they want to lurch leftward to a big-government tax-and-spend regulatory approach. Instead, we need to put all three legs of the Mundell hypothesis in place. And we're already two-thirds of the way there.
Treasury man Henry Paulson is using a $700 billion rescue package to prop up banks with new capital, purchase distressed assets and backstop inter-bank lending. Keynesian deficits will finance it. But it's working. While ankle biters on the left and right have dissed Paulson's plan, important credit-market spreads have declined significantly in the last two weeks.
Fed head Ben Bernanke, meanwhile, is combating deflation with a Friedmanite monetarist approach -- the second leg of the Mundell mix. Over the past two months the Fed has doubled its balance sheet and spurred a major increase in the basic money supply in order to meet the enormous liquidity demands that always accompany deflation. The Fed should keep this up in the coming months until stocks, commodities and credit show life-signs of recovery.
But what's missing is Mundell's third policy leg: supply-side tax cuts. And here we find the partisan debate of the closing days of the presidential and congressional elections.....
Read entire article at Real Clear Politics
So I asked Prof. Mundell, who later won a Nobel Prize in economics, whether Reagan's supply-side tax cuts would be sufficient to cure the economy. The professor answered that during periods of crisis, sometimes you have to be a supply-sider (tax rates), sometimes a monetarist (Fed money supply) and sometimes a Keynesian (federal deficits).
I've never forgotten that advice. Mundell was saying: Choose the best policies as put forth by the great economic philosophers without being too rigid.
Of course, John Maynard Keynes was a deficit spender during the Depression. Milton Friedman warned of printing too much or too little money. And Mundell, along with Art Laffer, Jack Kemp and others, revived the importance of reducing high marginal tax rates to reward work, investment and risk. The idea was to make each of these activities pay more after tax, and in the process boost asset values across the board. This incentive model of economic growth was used effectively by President John F. Kennedy and the great 1920s Treasury man, Andrew Mellon.
During the 1980s, Reagan enacted Mundell's three-legged approach. He slashed tax rates on the supply-side and was not afraid to run budget deficits in the Keynesian mold. At the same time, Reagan gave Paul Volcker carte blanche to practice the tough-minded monetarism that curbed excess money and vanquished inflation. This eclectic policy mix reignited economic growth, and it ushered in a near three-decade prosperity boom that revived free-market capitalism.
Today, however, the economic naysayers are ignoring the advice of Mundell. Looking at our financial crisis, with its deflationary sweep from stock markets to home prices to energy, they want to lurch leftward to a big-government tax-and-spend regulatory approach. Instead, we need to put all three legs of the Mundell hypothesis in place. And we're already two-thirds of the way there.
Treasury man Henry Paulson is using a $700 billion rescue package to prop up banks with new capital, purchase distressed assets and backstop inter-bank lending. Keynesian deficits will finance it. But it's working. While ankle biters on the left and right have dissed Paulson's plan, important credit-market spreads have declined significantly in the last two weeks.
Fed head Ben Bernanke, meanwhile, is combating deflation with a Friedmanite monetarist approach -- the second leg of the Mundell mix. Over the past two months the Fed has doubled its balance sheet and spurred a major increase in the basic money supply in order to meet the enormous liquidity demands that always accompany deflation. The Fed should keep this up in the coming months until stocks, commodities and credit show life-signs of recovery.
But what's missing is Mundell's third policy leg: supply-side tax cuts. And here we find the partisan debate of the closing days of the presidential and congressional elections.....