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Jewish World Review Oct. 22, 1999 /12 Mar-Cheshvan, 5760

Lawrence Kudlow

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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 to Mundell.

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 you, Professor Mundell.

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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©1999, Lawrence Kudlow