Another laugher from Arthur Laffer

The brain behind supply-side economics goofs again.

Published October 27, 2008 3:29PM (EDT)

Over the years, I have learned not to devote too many of my precious brain cells to opinion pieces in the Wall Street Journal -- my blood pressure disapproves of the aggravation. But the headline "The End of Prosperity" sounded excessively gloomy for the flag-bearer of free market fundamentalism, so I took a gander.

Arthur Laffer, famous for his "Laffer Curve" theory that tax cuts pay for themselves through the increased government revenue generated by a growing economy -- the bedrock of supply-side economics -- is very unhappy with the efforts to stabilize the economy undertaken by Ben Bernanke, Hank Paulson and friends. He's even unhappier with the prospect of Democrats taking greater control of the government.

A sample:

If you don't believe me, just watch how Congress and Barney Frank run the banks. If you thought they did a bad job running the post office, Amtrak, Fannie Mae, Freddie Mac and the military, just wait till you see what they'll do with Wall Street.

An easy retort would be to ask how activist Democrats could do any worse than deregulatory Republicans, and we could have some fun discussing the bogosity of the Laffer Curve -- basically, while there might be some economic juice to be gained from cutting very high tax rates, the vast majority of economists now agree that, in general, tax cuts to do not pay for themselves. This is particularly true when the tax cuts are not matched with spending cuts, thus resulting in ballooning deficits, which someday must be paid for, most likely by raising taxes.

But that's old news. Predictably, my ire was exercised by Laffer before the end of the second paragraph.

Financial panics, if left alone, rarely cause much damage to the real economy, output, employment or production.

This is demonstrably untrue. Has Laffer forgotten the 19th century? Let's turn the microphone over to U.C. San Diego's James Hamilton:

Financial or banking panics were a recurrent theme in 19th-century U.S. economic history.

Episodes such as the Panic of 1857, Panic of 1873, Panic of 1893, Panic of 1896, and Panic of 1907 were marked by a sudden rise in short-term interest rates and an increase in the yield spread between safe and risky assets, as borrowers scrambled to find a source for short-term loans and depositors tried to get their money back from banks. These episodes were invariably followed by significant economic downturns.

I've already noted, twice, how the financial panic of 1873 precipitated the Long Depression, an economic downturn so dire that only the Great Depression could erase it from our cultural memory. Financial panics obviously have huge potential for causing downturns. It is very striking that since the creation of the Federal Reserve in 1913, and with the obvious, and huge, exception of the Great Depression, financial panics have not incurred the same catastrophic effects as they did in the 19th century. This is precisely because the Federal Reserve has been around to provide liquidity and stabilize the banking system when Wall Street does run amok.

Will Democrats prove able to fine-tune our regulatory infrastructure and improve the real economy's ability to withstand irresponsible Wall Street behavior? That is a truly open question. But should they try? Again, it's hard to see how they could do any worse than what we've just witnessed.


By Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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