Monday, October 27, 2008

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, if President 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 three-decade prosperity boom that revived free-market capitalism.

Today, however, the economic naysayers are ignoring the advice of Prof. 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.

Democrats want to tax the rich, redistribute the wealth, and spend our way out of the economic doldrums. It won’t work. Senators Barack Obama and Harry Reid, along with Speaker Nancy Pelosi, disdain supply-side tax incentives. But Sen. John McCain wants to reemploy them as a recovery tool. McCain is right, and now is the time for the Republican party to call for sweeping tax cuts that would reduce marginal rates by half for businesses, individuals, and investors. Yes, it would be bold. But no bolder than Reagan in the 1980s, Kennedy in the 1960s, or Mellon in the 1920s.

The corporate tax rate should be slashed from 35 percent to less than 25 percent, including capital-gains. (Corporations, let’s not forget, don’t pay taxes. Only individuals do, since business costs are passed along to consumers.) The top individual rate should similarly be lowered, with fewer income brackets to clutter up the tax code. And investment taxes on capital-gains and dividends should be cut from 15 percent to 7.5 percent to revive the dormant animal spirits of investors.

These tax cuts would mean all three legs of Robert Mundell’s pragmatic approach to policy are in place. Use the money supply to combat deflation (inflation is not the problem), employ deficits to rescue and stabilize the banking and credit system, and slash tax rates to reignite economic growth.

In effect, a successful rescue plan requires a drawdown of all the major economic schools of thought. Given the current economic emergency, we need all the help we can get. For a change, how about a little pragmatism in the policy mix? That just might do the trick.


Intrade said...

HazeNYC said :

    the problem is each of these approaches is shortsighted.. the fed and gov't is pumping dollars to bailout banks, writing tax-refund stimulus checks and so forth. Only 6 months ago hard asset prices were at near-term highs and the dollar relatively low against world currencies. How soon we forget! With the fall of major financial instituions and a shift towards deleveraging, sure the dollar will be artificially boosted in value at the expense of asset prices (and other currencies .. except the Yen perhaps!) but when the dust has settled and the debt-to-equity ratios have become more reasonable the market will realize that "suddenly" there is a huge overabundance of currency-- dollars especially but also throughout the world... and then we will hyperinflate on a scale not seen in the developed world since the reconstruction of Germany after WWII.
We need economic policy that will correct current crises and at minimal detriment to the population, but also with enough foresight not to simply fix one problem to create another.

Intrade said...

HHA said :

    What Kudlow fails to mention here is that supply-side economics has been roundly dismissed in the economics world. It carries the same sort of weight today as alchemy and astrology, which explains why one can very rarely, if ever, find a peer-reviewed article propounding supply-side economics anymore.

We have half a trillion dollar deficit already and Mr. Kudlow is proposing to blow that out of the water by introducing MORE tax cuts a.k.a. lower revenues while increasing spending at the same time. If we've learned anything over these last few years, it should be that debt matters.

Intrade said...

rwaz said :

    Well let's think about this. It seems like yesterday that tax cuts on income, cap gains, and dividends were supposed to lead us to stock market nirvana. And the budget would supposedly be balanced at the same time. Whoowee boys! It looks like to me that the opposite has occurred. Apparently the wealthy took their tax cuts and bought McMansions and Hummers. Oil went through the roof and we are staring at a $1 trillion deficit. The six figure tax cuts have been wiped out in the stock market. There's no free lunch here as the supply siders seem to think. Stop worshipping Reagan and see how you're destroying the country. If you voted for Bush you got what you deserve.I just hope the global markets can hold on for 2 more months.

Intrade said...

Question said :

    Mr. Kudlow, what will you do after you cut taxes to 0?

Intrade said...

Woof said :

    We need all the help we can get: Well, at least you got the title right. The people who got good jobs or are otherwise well off don't need any help. The people who are jobless, in trouble with bills and rents and mortgages, etc, yup, they need all the help they can get. But the american people at large, in general and specifically, congress, senate, fed, treasury, etc. etc. are too envious, greedy, selfish to see any of that. Tax cuts don't help any of these people, because for a tax cut to help, you must have taxable income to begin with. But that does not enter into all these "blind by design" equations. This is not a democratic vs. republican problem, it's a simple "truthiness" problem.

Intrade said...

jwQuest said :

    Tax cuts for the wealthy = biggest deficits in US History under GWBush and Ronald Reagan. The reverse-Robin Hood voodoo/Friedman/supply-side/trickle-down economic theory can now be seen for what it is: one of the biggest Ponzi scams in human history.
Over the past 4 decades, Kudlow,Republicans and power elite espousing his policies of greed have decimated the middle class (remember when 1 family breadwinner was sufficient?), busted unions, destroyed our manufacturing base, outsourced millions of US jobs, and insisted upon maintaining our dependence on foreign oil, while leaving the US infrastructure crumbling and rotting. AND ALWAYS, ALWAYS they say that "free markets" and "lower income/capital gains/inheritance" taxes (especially for corporations and the wealthiest) are the answer to any imagineable situation and problem. In different centuries, such repressive policies and behaviour spawned revolutions in Europe as well as a big one here in 1776.

Fortunately this is not Europe and, as Americans, we remain docile domestically. But the Kudlow Bio might better read ... "integrity acquired over a storied career stealing for three decades".

Intrade said...

Florida said :

    Kudlow really fancies himself an economist, doesn't he? Too bad he can offer little more than parroted 20-year-stale Reaganomics talking points. With "Kudlow and Company" offering analysis as bluntly retarded as the above, he may soon join the rest of the jobless here in the 21st century!

Intrade said...

Econ AL said :

    The way to job creation and expansion is tax cuts. The budget issues need a GROWING economy and the wars we are fighting are also an issue. The middle class has suffered because USA is losing manufacturing jobs to cheaper labor. The whole world uses oil, it is not US dependence on oil, it is a necessity. It will take time to go from an oil based economy to "something" else. The world will also have to come along on that trip... And the tax cuts will never go to zero.

Intrade said...

bunky58 said :

    Mr. Kudlow it is your philosophy that has got us in this mess. Why don't we just let China pay for everything and cut taxes 100 percent? Reagan raised taxes in 82,85,and 86 after the 81 cut. I will take Clinton Reich economics anyday over Reagan Bush McCain.

Intrade said...

JMelton said :

    Cutting tax rates for the wealthy has been the mantra since Reagan. If it works, it's already been done.

Meanwhile, the difference between the rich and the poor in this country has grown. It seems that cutting taxes on the rich does create wealth -- for the rich. Not so much for people who buy their gasoline one tank at a time and only own enough clothes to last till washday.

If anyone has forgotten, the 1920s ended in a huge stock market crash, so advice as to how to create another one is something we don't need right now. In the 1960s, a techno-boom drove the world's wheels and a blind mole rat with a dart gun could have designed a winning financial strategy.

So, just repeating that lowering taxes on the rich will make us all wealthy sounds like religion, not finance. Hallelujah and please pass the biscuits. Not the green ones the cow left in the yard, please.

Intrade said...

KudlowFan said :

    Hi Larry, great piece! Have you given the idea of abolishing the Federal Reserve any thought? What about the government creating interest free money? Why don't we simply create government bills, pay down all the debt with interest free money, deposit them in banks and increase fractional reserve requirements to 100% to stave off inflation. Wouldn't that be great? Keep up the good work.

Intrade said...

AAA said :

    with all due respect to supply sider, Mr Kudlow, Kindelberger, VOn Mises and Hayek shoudl be coming to mind now and not Keynes or Friedman.

Intrade said... said :

    Just more garabage by someone feeding us the same garbage for years. Supply-side economics only works in a textbook. Reagan and Bush prove that it does not work. Rich people simply do not spend money like poor people do.
Instead that money gets tucked away into an offshore bank account somewhere. It was simply an argument to help make rich people even richer, and the great chasm between rich and poor shows that the only thing that "trickles" down is a load of garbage.
Thanks to Reagan and Bush who have reckelessly spent money that this country did not have we have a $10 trillion debt that our children will be paying for forever.
Furthermore, Mr. Kudlow has little credibility having been a big drug user and an economic theorist from a bygone era.
Unlike, Kramer he has never earned money other than preaching theories from textbooks that have worked only in a textbook.
It would be best if Larry and his impractical theories could "trickle" away.

Intrade said...

re: kudlowfan said :

    We need interest/inflation right now in order for the US gov't to pay off it's massive debts.. if we could inflate as to reduce the value of dollar by say 10% then suddenly the principal we owe on debts originated before the inflationary period are now 10% less in value too! :)
Also we need interest rates to keep economic growth in our country steady.. if all other developed nations pay interest and we do not firstly the dollar will lose much of its value (but that DOES mean inflation!!) and people will stop lending money to each other or to the gov't.

Intrade said...

Ace said :

    supply-side economics has never been proven to work, in fact we have learned it does not work..........Sorry Larry!!!

Intrade said...

Re: Re: KudlowFan said :

    It is impossible to inflate to pay down the debt, because the only way to inflate is to create more debt. KudlowFan was correct, we have to pay down the debt using interest free non-fed created money. We need to go back to Lincoln's greenbacks and abolish the private ownership of central banks.

Intrade said...

r u serious said :

    in the strange world of media the intellectual insignificance of an idea is inversely proportional to the attention the idea and its author will receive.
are you serious? no i don't mean kudlow. i mean you guys. this guy is a jackass. and he is doing what he does best. bray loudly. caveat emptor people.

Intrade said...

Re: Re: Re: KudlowFan said :

    creation of debt is NOT the only way to create inflation.. creation of CURRENCY leads to inflation.. so if we print more dollars or euros or mine more gold (as what happened in 17th century Spain after the treasure ships brought back so much gold from S.America that the value of Silver actually exceeded that of gold!) then prices of goods will rise and that is the definition of inflation.
I agree paying down debts is the way to go.. we need to also curb spending govt and consumer.. live within our real means.. and *gasp* raise taxes!

Intrade said...

Nancy Brumback said :

    1. Tax cuts for the wealthy don't create jobs; demand creates jobs. Without demand, there is no economic need to be filled. Excess money in the hands of the wealthy translates to jobs only when there is unmet economic demand.

2. Kudlow says that corporations don’t pay taxes. "Only individuals do, since business costs are passed along to consumers." But corporations don't fix prices, the market does.

Intrade said...

Re: Re: Re: Re: KudlowFan said :

    What you fail to realize is that today's currency *IS* debt. The Lincoln greenback was currency that was not created by debt. Also, 90% of inflation is caused by the fractional reserve banking system. If we printed interest free money to pay off the debt while at the same time eliminate fractional reserve lending, we will stave off 90% of the inflation it would create.

Intrade said...

jhr00000 said :

    I, for one, would like to thank Mr. Kudlow for encouraging McCain to pick Sarah Palin. Barring massive election fraud or the Supreme Court trumping the will of the people, Mr. Kudlow will have sealed the election for Barack Obama. I guess his economic theories are about well reasoned as his political instincts.

Intrade said...

LJR said :

    Drop dead, Kudlow.

Intrade said...

KeithOlbermann said :

    Are you going to open your show with "Free market capitalization is the best path to prosperity" now?

Intrade said...

bugsy113 said :

    How about the massive economic stimulus of fixing the health care crisis. If companies no longer had to bear the burden of providing for health insurance. Imagine the amount of Americans these companies could hire right here. They want employees that are local easy to manage and understand what they are being told to do. If we could have a health care system that everyone paid for not just 40 percent the stimulus would be unstoppable.

Intrade said...

rich said :

    Answer how a business can pass along an increase in taxes, when it is facing competition?

Intrade said...

Oskar Lange said :


If many firms face the same increase in taxes, they will pass a portion of the tax increase on to consumers--the amount depends on the relative elasticities of supply and demand. While it's true that a single firm facing increasing costs in a perfectly competitive market cannot pass any of the tax increase on to consumers, no tax plan would target a single firm and, in practice, no market is perfectly competitive.

Intrade said...

golden27 said :

    if kudlow is correct, and i do think he is on the right track.....then how could any right thinking "business" person vote for obama?? how can we keep pelosi and reid, and frank and dodd in power?? they want to allow the printing of money, for one purpose only, to fund their pet projects. this in reality ignores their democratic base: the middle class and little people they ride on to power. god bless america. and, remember, we will get what/who the majority votes for. does noon remember jimma carter ??!!

Intrade said...

The Blumpkin from Raleigh, NC said :

    The way to job creation is education and business and consumer incentives- I hope thats what the Democrats call their pet projects. I remember 'ol Jimmy and Volcker- though inflation isn't our current problem. Free market capitalism is beautiful (amd we'll need some tax incentives to strive) except when we splurge and blow money on unsustainable crap or credit. How 'bout you tax us on our consumption? Then we'll realize we can't afford credit card bill sooner- b/c we can't afford to pay the tax. WOW- there sure is alot of republican hate on this blog! The past is the past and I hear you, but lets not swing too much farther left guys. Lets take the best the of the right side economics (which is historically the better) and make some good decisions for the future.

PS- Union busting and exporting jobs??? This is a flat world, don't tell me you stuck in a ditch! I'm suprised Ford, Chevy, or Chrysler havn't gone out of business yet! Get into solar energy, hydroponics, or biofuels.

Intrade said...

Bush a supply sider? said :

    Ok he had some tax cuts...but he propped up demand by encouraging us to spend. He sold us a war for crist sake! Your not fooling me. Bush fell asleep in Econ class.

Intrade said...

small government anyone? said :

    I think the solution is very simple. If you don't pay taxes, you don't get to vote. Simple as that. Within one or two elections cycles, we could slash about a trillion dollars worth of social welfare out of the bloated federal budget. Turn that into a 33% across the board tax cut to every TAXPAYER. That trillion dollars would end up back in the productive sector where it would create such a boon that you'd have to run and hide from a job. While we're at it, let's stoke the fire a little more by switching to the fair tax, eliminating corporate and personal income taxes and taking a wrecking ball to the IRS. That would free up another half trillion dollars which is currently being wasted on trying to comply with the insane tax code. That would add up to about 10 times the "economic stimulus plan" Bush trumpted about, without all the bad debt. It's time we make America an off shore tax shelter for the rest of the world, instead of the other way around. And speaking of Ponzi schemes, how 'bout taking the axe to that social security boondoggle and giving us our money now while we still have time to invest it in something that will actually give us a retirement before we're too old to live. That, of course, would also have the benefit of putting a boatload of investment money back into American industry. You can argue all the economic theories that you want, but one things is certain and that is socialism doesn't work. The bigger the government gets, the worse off we become, because government is power and that power is never used in the way you want it used. Return the power to the individual. It's high time to send the great society to the ash heap of history before we spend and borrow our way into oblivion. Let's get back to the fundamentals that made America great: hard work, charity, personal responsibility and small government.

Intrade said...

SRQ said :

    F. A. Hayek, the nobel prize winning economist would completely disagree here. Economic laws are just that, laws. They don't change based on whatever the present circumstances are. The present circumstances change based on those laws and booms and busts are created by governmental economic policies. Anyone wanting to actually learn why the economy does what it does needs to understand the Austrian Theory of the Business Cycle. An outstanding explanation of our current mess can be found here at

Since Kudlow, like most other psuedo-intellectual "business" types are unable to explain the boom and bust cycle, they continue to say things like this. It makes absolutely no logical sense that since this recession was created by too much liquidity that clearly the answer is more liquidity. Americans continue to suffer under a misconception of how the economy actually works.