Jewish World Review Oct. 22, 1999 /12 Mar-Cheshvan, 5760
Supply-Side Is Mainstream
NEARLY THIRTY YEARS AGO Robert A. Mundell was the first economist to
predict the calamitous inflation that occurred in America and the rest
of the world during the 1970s. It was a great call. By itself, this
forecast justified the Nobel Prize in Economic Science just awarded
He knew then that the breakdown of the Bretton Woods gold-based
fixed exchange rate system would leave the world's paper money supply anchor-less
and value-less. He believed that without a clear standard or yardstick to maintain
currency value, rudderless central bankers would wind up acceding to the political
demands of monetary expansion and blunder their way into double-digit inflation. So
they did. And the global economy was impoverished for over a decade.
Keynesian economic thinkers during this period were baffled by the recurring
combination of high inflation and high unemployment (just as they are still baffled today
by the recurrence of low inflation and low unemployment). They couldn't solve the
problem of stagflation. Their Phillips curves were useless.
Mundell, however, turned the Keynesian demand model on its head. Instead of the
notion that taxes should be raised to curb "excess demand" (or "overheating"), Mundell
argued that inflation is a monetary problem that can only be cured by an increase in
dollar purchasing power value.
Instead of the Keynesian view that easy money would stimulate growth and
employment, Mundell wrote that only tax-rate reduction (including lower tariffs) would
restore the necessary worker rewards and investment incentives to increase the supply
of new jobs, production, capital formation and growth.
In other words, Mundell's great contribution is his redefinition of the optimal mix of policy
instruments: low taxes solve recession, hard money solves inflation. Exactly the reverse
of the Keynesian view.
Forty-one million new jobs later, after nearly eighteen consecutive years of economic
prosperity, with an inflation rate below 2% and an unemployment rate just above 4%, a
remarkable outburst of technological innovation, and a bull market in stocks that has
created nearly $30 trillion in new household wealth, we all owe an enormous debt of
gratitude to Robert Mundell.
At exactly the right moment in history, Ronald Reagan became president and
implemented Mundell's theory of sound money to vanquish inflation and marginal
tax-rate reduction to restore economic growth.
Reagan advisors such as Arthur Laffer, Jack Kemp, Martin Anderson, Norman Ture and
others relentlessly urged the Gipper to implement supply-side tax cuts. And he did.
Paul Volcker resisted the tax-cut idea, but he did follow through on re-linking the dollar
to a gold-backed monetary price rule. Inflation quickly fell.
Nowadays only extremists advocate money supply pump-priming to stimulate economic
growth. It's a discredited theory. Likewise, very few politicians believe that nations can
tax their way into prosperity. Those that persist in this outdated thinking are swiftly
punished on election day (such as Newt Gingrich's defeat of Bill Clinton in 1994).
Bob Mundell's economic wisdom casts an even larger net. He is also the father of
optimal currency areas. In his great book "Monetary Theory," published in 1971 when he
was an economics professor at the University of Chicago (he now teaches at Columbia),
he proposed a common currency for Europe, a second for the Americas, and a third for
Japan and Asia.
Today, of course, the Euro has come to pass. North and South America have effectively
been dollarized. And if the recovery of Japan and its yen continue, then an Asian
currency union will not be far off.
What's more, Mundell strongly believes in integrated global markets. Trade barriers
must be eliminated; the free flow movement of people and capital is essential to promote
expanded competition and global prosperity.
Mundell also wrote that current account trade deficits were the logical result of faster
economic growth, a development to be welcomed, not feared. Early on in the new
floating exchange rate world, he recognized that capital would flow in to healthy
economies, thereby balancing the aggregate books. Economies in need of more money
would be more than happy to give up their goods in exchange.
Awarding Mundell the prestigious Nobel Prize confers a mainstream stamp of approval
on his supply-side ideas. They will be taught in universities everywhere. New generation
economists will bring these thoughts to the high table of economic policy as they advise
politicians around the world.
Over time, I believe the new free-market technology-driven global economy will become
more and more Mundellian. That is why I ranked Bob Mundell and Art Laffer the two
most important 20th century living economic greats in my book "American Abundance,"
published two years ago. (Classical Austrian technologist Joseph Schumpeter remains
my favorite dead economist.)
In order to nurture and expand the current prosperity into the new century, everyone
involved in public policy should read Mundell. And Schumpeter, and von Mises, and
Hayek, and other free-market theorists.
Under the umbrella of democracy, sound money, low taxes, free trade, deregulation and
private property are the essential elements of economic freedom. In this setting,
technological innovation will flourish.
Then ordinary people everywhere on the planet will produce more wealth and prosperity
than nearly anyone dreams possible. Optimism will triumph, pessimism will fade. Thank
JWR contributor Lawrence Kudlow is chief economist for Schroder & Co. Inc and CNBC. He is the author of American Abundance: The New Economic & Moral Prosperity. Send your comments about his column by clicking here.
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08/26/99: Let Prices Rule
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©1999, Lawrence Kudlow