The Phillips Curve: Bernanke v. Kudlow

Lawrence Kudlow once again is guilty of either stupidity or mendacity (or both) as misrepresents a speech by Ben Bernanke:

It’s always amazing to listen to conventional demand-side economic pundits and mainstream reporters who try as hard as they can to minimize the excellent performance of the American economy ever since lower marginal tax-rate incentives were put into place almost two-and-a-half years ago … Apart from the inherent resiliency of our free-market capitalist economy, the fact remains that tax-induced capital cost reduction and resulting higher investment returns have boosted investment, healed business woes, and created employment growth near 2 million new jobs a year (and nearly 5 million since the middle of 2003 when the Bush tax cuts were implemented)… Of course, you can’t please the worrywarts. Yesterday they complained that wages weren’t rising; today they’re bellyaching that wage growth is too fast and that the Fed is going to have to tighten monetary policy much more in order to ward off cost-push inflation. This is more bogus Phillips-curve argument. But growth does not cause inflation. Fortunately, new Federal Reserve chairman Ben Bernanke rebutted the Phillips-curve view in a recent speech at Princeton. Bernanke correctly argued that low inflation promotes economic growth and that strong economic growth is something to be desired, not shunned. The Fed chair cited Milton Friedman’s argument of nearly fifty years ago that inflation is a monetary phenomenon and not a function of too many people working or prospering … Reagan economic guru Art Laffer taught us thirty years ago that lower tax rates ignite economic growth. Now, the Laffer curve is tracking a business-led expansion that is throwing off record budget revenues while corporate profits are soaring. Profits are the mother’s milk of business, the economy, and stocks, and are laying the foundation for even more hefty job gains … In the months ahead, Ben Bernanke will follow the anti-inflation thinking of Milton Friedman. President Bush will continue to embrace the pro-growth Laffer curve. And the anti-worker Phillips curve will be pushed into the dustbin of history. In other words, economic growth principles will keep American capitalism on the prosperity path.

Where to begin addressing the collection of contradictory BS? First of all, Bernanke did not endorse Kudlow’s brand of free lunch bologna. In fact, James Hamilton has very clearly explained why the Bernanke FED is running tight money – to offset the unwise fiscal stimulus that Kudlow advocates. As Dr. Hamilton notes – the result will be a higher cost of capital and less investment for long-term growth.

Now Kudlow wants you to believe that we have repealed the full employment constraint. If he actually believes that, he should re-read Bernanke’s speech:

Notably, during the 1960s and early 1970s, some policymakers appeared to believe that price stability and high employment were substitutes, not complements. Specifically, some influential voices of the time argued that, by accepting higher inflation, policymakers could bring about a permanently lower rate of unemployment … The idea of the permanent tradeoff did not go unchallenged, however. In 1967, economists Milton Friedman and Edmund Phelps independently produced influential critiques of this view. Their key contribution was to observe that, if inflation expectations react to changes in actual inflation in an economically reasonable way, then any tradeoff between inflation and unemployment would be short-lived at best … Over a short period, then, higher inflation might bring lower unemployment, consistent with the empirical results found by Phillips.

Let me correct a misrepresentation of the advice that President Johnson was receiving in the latter part of 1965. His Keynesian advisors sensed that the combination of Vietnam War spending, the Great Society spending, and the extra consumption demand from the 1964 tax cut would lead to a Faustian choice – either have the FED raise interest rate as they did during the 1966 Credit Crunch or let inflation accelerate – which alas happened when the FED lost its political will to follow the advice of these Keynesian economists. Kudlow’s mentor – Art Laffer – is a mentee of Norman Ture who in 1966 was saying we did not need fiscal restraint. Ture was wrong as in Kudlow. And yet Kudlow has the gall to blame the Keynesian advisors who gave the President the correct advice? Pathetic!