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Table of contents :
Chapter 1: American Abundance
Chapter 2: In the Scope of Paul Baran
Elective Affinities
The Way to the Ph.D.
Chapter 3: “Growth and the Balance of Payments”
Brookings and the Dollar Crisis
“An Anti-Traditional Theory”
The Platform of Supply-Side Economics
Chapter 4: Rising at Chicago
Not “An Anti-Traditional” But “A Monetary”
Publishing into the Crisis
Chapter 5: “A Formal Model of the Economy”
1065 Comes to OMB
Going Public
Chapter 6: 1065
Samuelson on Tape
The Ph.D. Fiasco
“The Destiny of Man”
Chapter 7: Toward the Policy Mix
Back to Academia
Debut at the Journal
The Slutsky Effect
Chapter 8: The Laffer Curve
Two Continents
Michael 1
Capital Moves
Chapter 9: Global Monetarism
Waning in Academia
Chapter 10: The Arc of Reform
A Note on Sources
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The Emergence of Arthur Laffer The Foundations of SupplySide Economics in Chicago and Washington, 1966–1976 Brian Domitrovic

Archival Insights into the Evolution of Economics Series Editor Robert Leeson Stanford University Stanford, CA, USA

This series provides unique archival insights into the evolution of economics. Each volume examines the defining controversies of one or more of the major schools. More information about this series at

Brian Domitrovic

The Emergence of Arthur Laffer The Foundations of Supply-Side Economics in Chicago and Washington, 1966–1976

Brian Domitrovic The Laffer Center The Woodlands, TX, USA

ISSN 2662-6195     ISSN 2662-6209 (electronic) Archival Insights into the Evolution of Economics ISBN 978-3-030-65553-2    ISBN 978-3-030-65554-9 (eBook) © The Editor(s) (if applicable) and The Author(s), under exclusive licence to Springer Nature Switzerland AG 2021 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG. The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

For Bob Mundell


For supply of information central to this book’s content, Arthur Laffer has been both forthcoming about his life and career and helpful in finding, and often acquiring, further relevant sources. All six children in the Laffer family have been distinctly helpful as well, if Arthur Jr. and Rachel may be singled out. At the Laffer firm, Mike Madzin, Randi Butler, Nick Drinkwater, Kenny Smith, and Richard Neikirk have been of great assistance. Thanks as well go to Dick Strong, Bob Mundell, Valerie Natsios-­ Mundell, Mark Molesky, Steve Forbes, Robert Leeson, Nathan Lewis, Ralph Benko, Larry Kudlow, Don Critchlow, Marc Miles, Chuck Kadlec, Pinar Emiralioglu, Brian Jordan, Tony Batman, and Jeanne and Rex Sinquefield. And thanks go to Sam Houston State University and the staffs of archival collections, including those held at the Richard M.  Nixon Library, the Harry S. Truman Library, the Duke University Libraries, the University of Chicago Library, the MIT Libraries, the Economists’ Papers Archive at the Duke University Libraries, and depositories at Stanford and Yale.



1 American Abundance  1 2 In the Scope of Paul Baran 17 3 “Growth and the Balance of Payments” 41 4 Rising at Chicago 65 5 “A Formal Model of the Economy” 93 6 1065115 7 Toward the Policy Mix147 8 The Laffer Curve175




9 Global Monetarism205 10 The Arc of Reform239 A Note on Sources247 Index249


AEI American Enterprise Institute AER American Economic Review BoB Bureau of the Budget CEA Council of Economic Advisers CPI Consumer Price Index GDP Gross Domestic Product GNP Gross National Product GPO Government Printing Office IMF International Monetary Fund JPE Journal of Political Economy MESA Mechanics Educational Society of America NBER National Bureau of Economic Research NYT New York Times NIPA National Income and Product Accounts OMB Office of Management and Budget OPEC Organization of Petroleum Exporting Countries QJE Quarterly Journal of Economics RNPL Richard M. Nixon Presidential Library SDR Special Drawing Right SOMC Shadow Open Market Committee WHOF: SMOF White House Office Files: Staff Members’ Office Files, RNPL WP Washington Post WSJ Wall Street Journal



American Abundance

In Philip Roth’s 1959 novella Goodbye, Columbus, the protagonist, a young man who lives in the old section of Newark, is amazed at the prosperity he finds in the homes of some of his friends, including in the Short Hills, New Jersey, spread of the young lady he is courting. On the main floor of her home he finds himself chilling “in the steady coolness of air by Westinghouse.” The sporting goods on the lawn—these are a sight. “Outside, through the wide picture window, I could see the back lawn with its twin oak trees,” this protagonist, one Neil Klugman, narrates. “I say oaks, though fancifully, one might call them sporting-goods trees. Beneath their branches, like fruit dropped from their limbs, were two irons, a golf ball, a tennis can, a baseball bat, basketball, a first-baseman’s glove, and what was apparently a riding crop.” Soon to be discovered were a basketball court and a stopwatch. He goes down to her family’s basement and finds the refrigerator in that smartly renovated space to be “heaped with fruit, shelves swelled with it, every color, every texture, and hidden within, every kind of pit.” There are three kinds of plums, “long horns of grapes,” nectarines, peaches, various melons, “and cherries, cherries flowing out of boxes and staining everything scarlet.” He marvels at these people. “Fruit grew in their refrigerator and sporting goods dropped from their trees!” This is not to mention the family’s country club, or even the municipal tennis courts and running tracks. Everything is so nice. And

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 B. Domitrovic, The Emergence of Arthur Laffer, Archival Insights into the Evolution of Economics,




Neil always has a good time using all the stuff with his girlfriend and her family. Her father had built a little business installing bathroom porcelain. The point of the novella appears to be that Neil cannot let his rather mild mean and indifferent side from intruding on his courting of the young woman, and the force of this petty trait makes them break up. He looks at his reflection in her college-library window and asks himself why he cannot simply take advantage of the good things that he has before him. It was a tough question, and Roth did not answer it. This was the closing vignette of the book. “What was it that had turned winning into losing,” Neil asks himself as he stares at his reflection, wondering what unknown counterproductive forces are inside his head, allowing “and losing—who knows—into winning?” One of the central issues implied in Goodbye, Columbus was that something had to be made, some reckoning taken, of the blooming economic prosperity of the 1950s. The United States, if not much of the world recently cursed by the most horrible conflict, and prior to that the Great Depression, clearly had set to producing the likes of mass affluence once World War II was over with. The novella testified to this. But what if, welcomed into the expansiveness of a prosperity such as that of the postwar era, as Neil was via his girl, one is feckless, too much of a schmuck to enjoy it when offered? Is there something wrong with such a person—in terms of character, or morally? It could even be possible that at some level of consciousness such a person dislikes prosperity, would rather it moderate, and might be ready to take subtle action to see it curtailed. This is an unsettling thought. But human envy and willful incompetence have their native prowess. “I looked hard at that image of me, at that darkening of the glass,” Neil said, and then the image broke up, the questions cut off in various stages of being formed as they were summoned up from within.1 Neil’s girlfriend’s brother went to Ohio State University. He has a phonograph record of songs that the college band plays over announcements of the sports teams’ exploits. At the end, a voice expresses the sentiments of the graduating seniors, saying, “Goodbye, Columbus,” as in the location of the university, Columbus, Ohio. Going out to Ohio, that too was consistent, in the 1950s, with the habits of Eastern seaboarders who were living large in the great postwar prosperity. Ohio, the home of some of the greatest nineteenth-century enterprises that defined the twentieth ­century, Goodyear, Procter & Gamble, and Standard Oil, enterprises that swelled the life—the mass affluence of all the workers and the executives and their so often big and extended families—that great business success can carry



in its tow. It was a booming place, a reality that contemporary people accustomed to thinking, with no small amount of justification, of the near Midwest as rustbelt and opioid country may find hard to grasp. In 1940, perhaps the birth year of some of the members of that college band playing in “Goodbye, Columbus” with enthusiasm in the novella, Ohio was not such a place, even if it had recently endured the Depression. It was still fully an industrial powerhouse, and by virtue of that fact, an engine of livelihoods and prosperity. To be born in Ohio in 1940—something close to the acme and core, in terms of time and place, of that formerly proud, and now sometimes derided national ethos, the American Dream. Arthur Laffer was born in August of that year in the distinctive Ohio steel-mill town 150 miles to the northeast of Columbus, Youngstown. His family was on a brief business assignment there prior to returning to the ancestral home of Cleveland, where this future economist would grow up. His earliest memory is from 1945, when his grandparents had him in Arizona, giving him the run of the Pioneer Hotel in Tucson much like, he remembers, the fabled Eloise in the Plaza in New York. His parents were busy back east, his father completing his war work as a “dollar-a-year man” industrial executive. To soak up in childhood as a preface to a life in economics—that discipline seeking to know the ways of material thriving— the unfolding of American postwar prosperity beginning in 1945: this was some special school. Postwar prosperity was the greatest phenomenon in global mass well-­ being that has perhaps ever occurred. The throngs of people getting jobs, holding jobs, getting promotions, buying cars, moving into homes, taking vacations, saving money, inventing devices, starting businesses, and not only in the national location of the American Dream. As Laffer’s closest friend and confidante in the upcoming years, the economist and 1999 Nobel Prizewinner Robert Mundell, put it before Congress in 1965, “the most exceptional characteristic of the world economy in the past fifteen years is its unparalleled prosperity and stability. I can think of no comparable period in the whole of modern history.”2 Thirty years after his birth, Arthur Laffer was about the most successful young economist of his generation. In 1969, at the age of twenty-nine, he achieved professorial tenure at the University of Chicago. This was the economics faculty—Chicago’s in the 1960s—that has gone down in history as among the most intellectually distinguished (and assertive) as any on the American university scene from over the ages. It was the faculty of that household name Milton Friedman and included a roster of future



Nobel Prizewinners. Laffer got early tenure at this place. While he was taking graduate classes at Stanford University two years before, the American Economic Review published an article of his. A paper he presented at a hyper-critical Chicago economic “workshop” launched a revolution in international macroeconomics half a decade later, in the 1970s, even as it was never published. His dean at Chicago, George P.  Shultz, swept him in 1970 into a special position in presidential government, as inaugural economist at the White House’s new Office of Management and Budget (OMB). The economics of this young phenom had a central point. This was that postwar prosperity was going great. The point was obvious, perhaps, but Laffer brought mathematics and sequences of logic to his demonstrations. His chief area of interest was the international monetary system. He argued that the prevailing global arrangement of major currencies fixed at rates of exchange to the dollar, and the dollar itself to gold, was serving the needs of the world economy well. Great economic growth was the evidence. As a secondary interest he was curious about the dynamics of growth within a given country. What makes a domestic economy really move, given that there were so many nice examples in the 1960s—this was an interest he was developing at an increasing level of intensity, as his articles on the satisfactoriness of the current quasi-classical monetary system got published in all the top places. Laffer was successful as a young economist because of the intriguing way he posed his arguments to his peers in the academy. However, the thrust of his arguments, for saying that postwar prosperity was going great, made him exceptional. This point was not obvious within his field, the record shows. The regnant schools of macroeconomics, incumbent Keynesianism and the fully rising challenger monetarism, contended from their basic premises that the market economy cannot keep humming on its own and, moreover, that threats to economic stability and performance were gathering in the 1960s. The economy needed shrewd government interventions at every turn, and more than it was currently getting. Keynesianism wore such assumptions on its sleeve. Under the conditions of late capitalism, per John Maynard Keynes in his 1930s vein, those with money, the rich, are so satiated with the wealth accumulated over generations of success that they lose inspiration to invest. The lack of investment in such a context, a “liquidity trap,” in turn creates unemployment. The natural condition of the economy as a big industrial revolution progresses into its latter stages is that markets clear below the level of



employment, and therefore of general prosperity, that is socially acceptable. Government must step in, take the extra savings from the rich, and plow the money into productive investment. Or government must outright give these savings to the unemployed, so as to increase consumer demand and therefore the rate of return on investment, attracting the capital of languid rich into the marketplace.3 Monetarism was in an important sense no more sanguine about the ability of the market to clear at a high level of prosperity. In an early statement of his philosophy in the American Economic Review (AER) in 1948, monetarism’s chief exponent Friedman asserted that “government must provide a monetary framework for a competitive order since the competitive order cannot provide one for itself.” He proposed “a reform of the monetary and banking system to eliminate both the private creation or destruction of money,” if as well limiting by law the discretion of the government’s central-banking authority. Government, not the private sector at all, had to be the supplier of money in the interest, as in a term from the title of this 1948 article, “economic stability.” Left to its own devices, the private sector could never get currency issuance right. In such conditions, there were bound to be recessions when not bouts of inflation. Friedman’s analysis of why the private sector could not correctly produce a supply of money was not as dedicated as Keynes’s regarding the paucity of investment after a long industrial revolution. Friedman may well have taken the market’s natural instability as a given, so as to have a point of entry into the Keynesian discussion. Then he would turn the tables against Keynesianism and declare monetary as opposed to fiscal policy the main determinant. When Friedman was winning tenure and promotions at the University of Chicago from the late 1940s through the early 1960s, the path of least resistance into the great conversation of economics was to play along with the premises of Keynesianism.4 In their heyday, these theories put macroeconomics in a strange position with respect to real events. Postwar prosperity was clearly a fact. It was, furthermore, enduring, arguably getting better (growth was higher in the 1960s than the 1950s), and spreading into untouched places domestically and internationally. Therefore, according to both Keynesianism and monetarism, there had to be judicious interventions taking place all the while on the part of government. There had to be, for the one school of thought, fiscal policy addressing the problem of the settled rich’s weak propensity to invest; and for the other, steady and intelligent government management of the money supply. If these things did not obtain, if they



were not in fact happening as postwar prosperity sustained itself, then Keynesianism and monetarism would have to lose their priority. Indeed, they would be disproven. It therefore became an urgent matter for Keynesianism and monetarism not only to find examples of policy, in the 1950s and 1960s, that proved their relevance. It also became an existential imperative to reiterate the point that the economy was necessarily headed toward crisis. If the economy was not headed toward crisis as its natural course, Keynesianism and monetarism had no purchase. As for the location of the crisis in its nascent stage in the 1960s—the crisis had to be nascent as postwar prosperity proceeded apace—Keynesians and monetarists agreed where it was gathering most ominously. It was in the arrangements of the international monetary system, specifically as related to that system’s two central characteristics, fixed exchange rates and a dollar redeemable in gold. Within macroeconomics, the talk was incessant that the United States was running a chronic “deficit” within its “balance of payments” in the 1960s, meaning that in general, foreigners accumulated more dollar assets than Americans did foreign-currency assets. As dollar holdings stacked up among foreign holders, often central-­ bank reserve accounts, the American gold stock appeared to face a reckoning. If the foreign claimants to US gold acted on their rights to get gold for their dollars at the pre-fixed price, the system would lose its ability to function. The United States would run out of gold, and per a late World War II agreement—the protocols that came out of the Bretton Woods conference of 1944—countries were permitted not to guarantee their currencies’ exchange rates against the dollar if the dollar was not redeemable in gold. Therefore, the legacy gold/fixed-exchange-rate monetary system was revealing, in the 1960s, that it was untenable. The monetarists led by Friedman urged the dropping of gold and fixed rates for a floating exchange-rate system, in which currencies would trade against each other at whatever prices the market desired. Given such a switch, the looming balance-of-payments, gold-redemption comeuppance for the United States would not occur. The collateral benefit of flexible exchange rates, for monetarism, was the enabling of an independent money-supply policy. Under fixed rates, changes in the money supply put pressure on the exchange rate, which according to the rules had to stay the same. Flexible rates conferred a freedom in monetary policy such that authorities could pursue domestic unemployment and inflation goals without the impediment of having to maintain a currency par. Keynesians, for their part, wanted governments to have a free hand at running budget



deficits, changing the tax code, and engineering spending programs, all in the in the name of domestic aggregate demand and investment management. Budget deficits in particular notoriously spooked the exchange-rate markets. To overcome this obstacle, the best option was a “benign neglect” policy of letting the dollar-gold crisis mature until a transition from fixed to flexible exchange rates forced itself into being. From the perspectives of both monetarism and Keynesianism, the one way to achieve balance-of-­ payments equilibrium given gold and fixed rates was to slow down economic growth domestically. This was a horrible option and the real-world crisis that the extant system was courting.5 And yet here was this young tenured economist at Chicago, this Arthur Laffer, saying that the booming economy was excellent of its own accord and not heading toward crisis, in particular with regard to that whipping boy, the international monetary system. Fixed exchange rates for Laffer approximated perfection, as he said characteristically at a conference in January 1970: “With fixed exchange rates and price level flexibility…the real, as well as the nominal, money stock is perfectly elastic. Unemployment, as a result of monetary phenomena, should not exist.” No need for Keynesianism or monetarism—old-fashioned fixed exchange rates conduce to the results to which these two modernist schools aspired. “Although these two systems”—of flexible and fixed exchange rates—“are often thought of as analytically identical, the differences between them may be the difference between underemployment and prosperity.” As for the balance-of-payments crisis, he found it phony. From a journal article of his from 1969: “The United States should have over-all balance of payments deficits. Foreigners as well as the United States gain from the U.S. role as the international financial intermediary.” As for how to “solve” the balance-of-payments “crisis,” he had a solution in a 1969 paper, the one that upended the field the next decade: “An increase in the rate of growth of a country relative to the rest of the world will improve that country’s overall balance of payments.” In future years, he had a formula for “an increase in the rate of growth of a country,” substantial marginal tax cuts.6 The debates Laffer was joining in the first years of his career through 1970 were in the classic area of the free market versus government intervention. There had been such debates before, to be sure, but the prominent ones of several decades prior had not taken place when the market economy was successful and predominant. When F.A. Hayek issued his cri de coeur to the market of 1944, The Road to Serfdom, in the wake of the



Depression and during ultra-big-government World War II, the tone was unmistakably one of entreaty. Hayek’s dedication was “to the socialists of all parties,” conceding that there were quite a few socialists. Postwar prosperity presented the opposite problem as had the Great Depression. The Depression forced the defenders of the market to prove their relevance. Postwar prosperity forced the prophets of intervention to prove theirs. The preferred option, in the latter case, ultimately was to take refuge in the shadows, to see an unworkability in the international monetary system, of which most people were oblivious, as the mechanism of crisis. Meanwhile the experience of the continual postwar prosperity remained keen and palpable. Laffer therefore had a grand time as a kid economist, through at least 1970, tweaking the macroeconomic consensus. Paper after paper of his showed how fixed exchange rates and convertibility in gold—those fossils of the nineteenth century—were readily delivering postwar prosperity, with no natural end in sight. Gamely, these papers came out in the august places, the AER, the Journal of Political Economy, Harvard University Press. As Laffer made his contributions to the field, he got his tenure, promotion, citations, and invitations to speak—the accoutrements of a top economist arriviste. These times did not last. Just as Laffer climbed up to the pinnacle with tenure at Chicago, the United States did something inexplicable with respect to its beloved postwar prosperity. It traded winning for losing.

Stagflation The tennis cans, riding crops, overstuffed refrigerators, family cars, Silicon Valley startups, jobs-for-life, the various contents and trappings of the legendary postwar American abundance went alternatively scarce and dear in price in the years after 1969. The decade of the 1970s has gone down in history, justifiably, as that of “stagflation,” the difficult-to-grasp combination of minimal or negative economic growth with severe consumer-price inflation. The numbers confer the point. In the 1960s, there was a nine-­year boom of 5 percent annual growth in real economic output. Price increases averaged about a percent per year, tipping up to 5 percent at the end. From 1969 through 1982, there were four recessions, three of them double-­dip, and one of them, that of 1973–75, swallowing an entire year (1974). Unemployment naturally surged during these recessions, reaching shocking peaks of 9 percent in the mid-1970s and 11 percent in the early 1980s.



Consumer prices took off like a moonshot. From the time of the lunar rocket in 1969 until 1982, the increases were fully 165 percent—nearly 8 percent per year. It was true, apparently, that the economy of the 1950s and the 1960s had been careening toward crisis all along. Stagflation in the 1970s through the early 1980s showed it. Laffer therefore came into his own as a beacon of contrarian wisdom in these changed circumstances—perhaps one could suppose. This is not what occurred. Rather, the profession of academic economics all but expectorated him from its ranks. The great 1970s stagflation, at least over its first phase, when the public was still somewhat quiescent about it, functioned as a vindication of the king macroeconomic theories that had been crying crisis ever since postwar prosperity had gotten dismayingly regular. The calls welled up for the assistance of these theories in the early 1970s. Budget and tax policy had to be adjusted toward full employment— Keynesianism was in its cockpit. The Federal Reserve sure has made a mess of things now and it needs rules—monetarism had been waiting for this its whole life. Laffer and to be sure his redoubtable colleague Mundell were true enough to themselves to point out that the stagflation of the 1970s had come care of the specific “reform” which macroeconomics had been baying for and then finally got. In 1971, the United States stopped redemptions in gold for dollars, ending the gold standard. And within a year-and-a-half, by early 1973, all major currencies had abandoned fixed rates of exchange to one another. Now currencies “floated,” having a new value at every moment in the marketplace and inconvertible in gold or anything else—as had been the clear and interminably repeated recommendation of the macroeconomic profession for the past decade. There had been no crisis brewing in the economy, Laffer and Mundell said. Rather, the economy met a fate that the establishment of professional economics had engineered for it by means of maladroit policy. Laffer’s basic diagnosis was twofold. Inflation came care of “devaluation,” or a currency trading on the markets against other currencies for less than previously. Laffer spelled out, in a series of works in the early 1970s, how a domestic economy’s “relative price structure,” what each good and service costs in terms of every other good and service in the economy, generally stays stable. Therefore when imports become more expensive, as happens given a currency devaluation, the prices of all the other goods in the domestic economy go up to maintain the relative price structure against those imported goods. He found that numerically, the



levels were exact. If a currency devalues by 10 percent against the currencies of its major trading partners, the domestic price level will increase by 10 percent within the devaluing country. Stagnation, Laffer and Mundell reasoned together, came from the interaction of inflation with the tax code, which was for the great part, in the United States, “un-indexed” for inflation. If there was a 10 percent inflation and workers got 10 percent raises to make up for it, the 10 percent raises faced “marginal” rates on a progressive income-tax schedule that were higher than the average rate those workers had been paying in taxes. Therefore, the raises did not cover the increase in prices. People responded to this sort of development by among other things buying less, lowering output. If, alternatively, companies paid even more to keep their employees whole, profit margins went negative, forcing layoffs and lowering stock prices. The problem was more severe with respect to capital-­ gains taxation. And it all stemmed from the cashiering of gold and fixed exchange rates. Cui bono—a central question in source analysis. “Who benefits” when an action is taken? To the historian, understanding who benefits is the simple path to causation. If somebody benefits from a situation, then that somebody is a strong candidate for having caused that situation. Economics was prestigious in the late 1960s, about that there can be no doubt. Ivy League universities, named professorial chairs, top journals, grants, columns in the newsmagazines, places in government and even in business— all these bourgeois baubles had come to the profession in profusion by the 1960s. But economics was also misplaced in the world. Its major macroeconomic schools offered diagnoses that assumed a market tendency toward depression, or at least considerable variation in economic performance. The propensity for making such diagnoses reflected origins in the debates of the 1930s, but also a rigidity in dealing with a changing world— not to mention a desire to claim structural relevance for economics. When postwar prosperity emerged, the macroeconomists of the major schools either had to claim credit for the development, or the run had to end for them to remain vindicated. In the offing both things happened. On simple cui bono grounds, the question in regard to stagflation is why. Not only does it appear that macroeconomics played a major role in causing stagflation; it also appears that it was in its narrow self-interest to court and take on such a role. Under the pretext that it was discovered that he had never finished his Stanford Ph.D. degree, Laffer became a persona non grata at Chicago



after 1971. He cast around for other university appointments, landing one at the University of Southern California in 1976. In the meantime, he pressed on with work along the lines he had done prior to 1971, this time under the auspices of an urgent problem that had to be solved. The nation had to go back to fixed rates and probably gold, and it had to focus on real-life production instead of some succession of policy fixes recommended by an economic-advisory elite. He had a hard time getting his work past peer review—it had been so easy before 1971—but he had alternative audiences care of his spell at OMB. There he had become acquainted not only with major players in government, such as Richard M. Nixon and Gerald R. Ford administration officials Shultz, Donald H. Rumsfeld, and Richard Cheney. He also got to know major journalists, above all the new leadership of the editorial page of the Wall Street Journal, Robert L. Bartley and Jude Wanniski. Laffer started telling these people about his economics. As stagflation worsened, especially after the final collapse of fixed rates in early 1973, such high officials and thought leaders gave Laffer all sorts of attention. He found new platforms, such as the Journal editorial page, private seminars to rising Members of Congress and presidential officials, and legislative testimony. As the public found the huge double-dip inflationary recession of 1973–75 increasingly infuriating, Laffer started to become a national sage. It was sometime in this period that he first sketched out his curve relating tax rates against tax revenues, the “Laffer curve,” one of the most famous economics graphs—in terms of its popular recognizability— of all time. A contribution of this volume is to present the earliest extant version of the Laffer curve that has yet been discovered. Lore has it that Laffer first sketched the curve, sometime in 1974, “on the back of a paper napkin,” thanks to the recollection of Wanniski. The evidence here shows that Laffer had actually worked his curve out a great deal in modelling beforehand.7 Arthur Laffer has a twofold notoriety in modern American economic history. In the first place, he drew his curve. It got so much attention in the popular press in the late 1970s and early 1980s that, according to the calculations of economist Robert Shiller, it rivalled the chatter over major contemporaneous popular-cultural fads such as the Rubik’s cube. In the second place, Laffer was the one who introduced former California governor Ronald Reagan to the idea of cutting tax rates, and he assisted Reagan as an advisor through his victory in the presidential election in 1980 and his two-term presidency thereafter. Reagan had scarcely toyed with



cutting taxes, in practice as governor and as a promise on the presidential campaign stump in 1976, until on the arrangement of handlers who knew Laffer, Reagan was introduced to the thirty-five-year-old economist. Laffer made his case, and the germ of the signature Reagan economic policy—serial tax-rate cuts—took form as Reagan plotted his 1980 run.8 The Laffer of the time before he met Reagan is the subject of this book. It asks the question, where did this figure come from? And in particular, what was the source and origin of the views in which Laffer was so confident, and which proved so influential, in the arena of national politics in the late 1970s and the 1980s? The answer to these questions lies in the evidence Laffer set down in the eventful first phase of his career, from his papers published and unpublished, the government reports and memoranda he drew up, and the notes (such as those pertaining to the Laffer curve) that he set down in private but which we now have in the archives. The evidence comes on thick beginning in 1966, when as a Stanford graduate student Laffer first read Mundell’s paper on “Growth and the Balance of Payments” and, adoring it, decided that he had to get to Chicago and be Mundell’s colleague. This phase of his career ended as Laffer departed from Chicago ten years later, in 1976, decamping to an endowed chair at the University of Southern California and settling into the social circle of Ronald and Nancy Reagan. Perhaps as a collateral matter, the history of the first ten years of Laffer’s career must also be in good part a history of the unaccountably intense debates surrounding the international monetary system in the 1960s through the early 1970s. Outside of a handful of dedicated insiders in the likes of the International Monetary Fund, few people talk about the international monetary system today. It is perhaps difficult to convey how current, how imperative, was the issue, in the organs of intellectual and policy discussion in the late 1960s, of what kind of monetary system the world should have. It was a vogue issue then, and a minor one now. In the years before he drew his Laffer curve, this young economist had gotten terribly involved in the preeminent macroeconomic debate of the final years of the generation-long boom after World War II. As for the historiography that pertains to Laffer and the tradition of “supply-side economics” that he is rightly understood, with Mundell, to have captained, it has increased in extent and sophistication in recent years. However, the subject area has an unfortunate tendency to draw out methodological mediocrity from the researchers who study it. The simple problem is this: scholarly inquiries into the history of Laffer and his supply-side economics movement (as it came to be referred to after 1976)



have called on, in total, a small fraction of the possible sources. Reading a sample of a theoretician’s words will not equip the researcher to confer historical understanding; reading pertinent sources in fullness is a necessary condition of interpreting a few well. This is an axiom of historical methodology. There is a peremptory quality, a hastiness in historiography about supply-side economics and its practitioners, as if the conclusions are obvious. These people over-promised, were amateurish, or were in the pocket of the business establishment—to linger on sources after citing a few is unnecessary.9 Yet to linger on sources in this case is to begin to reveal profundity. And if the economics of Laffer, and that of his colleagues, was profound to some minimum degree, then the standard argumentative apparatus about supply-side economics being a “crank” movement that derailed the enlightened march of wisdom into policy via professionalization meets a formidable challenge. But the stakes are greater than this. In the early part of his career, and to an extent later, Laffer was an evocative participant in a major sociological transformation that was working its way through the United States. He was a high member of a new kind of elite, that of top academic economists, making a bid for relevance beyond any those in this station had claimed before, and at the expense of traditional social elites that were at the same time confronting their own impending decadence. In the balance hung the fate of a country grown accustomed to epochal prosperity.

Notes 1. Philip Roth, Novels & Stories 1959–1962 (New York: Library of America, 2005), 21, 37, 108. 2. Robert A. Mundell, “The Composition of International Reserves and the Future of the Dollar,” Guidelines for International Monetary Reform: Hearings before the Subcommittee on International Exchange and Payments of the Joint Economic Committee, July 28, 1965, p. 48. 3. Traditionally, the definition of the Keynesian liquidity trap is narrow and technical, referring to the near equivalence in the rate of return among interest-bearing instruments and cash. Given that Keynes’s observations about the liquidity preference involved comments on the slack nature of investment demand from the multi-generational rich, the term probably should refer to the general need, late in stages of extended economic development, for high rates of return to get the settled rich to part with their money via investment. In this sense is the term “liquidity trap” used in this



work. As Keynes wrote in the General Theory: “Not only is the marginal propensity to consume weaker in a wealthy community, but owing to its accumulation of capital being already larger, the opportunities for further investment are less attractive unless the rate of interest”—on comparatively passive financial assets—“falls at a sufficiently rapid rate.” John Maynard Keynes, The General Theory of Employment, Interest and Money (1936), ch. 3 part II, 4. Milton Friedman, “A Monetary and Fiscal Framework for Economic Stability,” AER 38, no. 3 (June 1948), 245–47. 5. The term “benign neglect” became current in international monetary reform circles after March 1970, when Nixon advisor Daniel P. Moynihan introduced it in the context of racial and urban policy. 6. Arthur B.  Laffer, “Two Arguments for Fixed Rates,” in The Economics of Common Currencies, eds. Harry G.  Johnson and Alexander K.  Swoboda (Cambridge, Mass: Harvard University Press, 1973), 32; “The U.S. Balance of Payments—A Financial Center View,” Law and Contemporary Problems 34, no. 1 (Winter 1969), 46; “An Anti-Traditional Theory of the Balance of Payments Under Fixed Exchange Rates,” unpublished manuscript, February 1969, Laffer archive, p. 22. 7. Jude Wanniski, The Way the World Works: How Economies Fail—and Succeed (New York: Basic Books, 1978), 288. 8. Robert J.  Shiller, “Narrative Economics,” Cowles Foundation Discussion Paper No. 2069, Yale University, p. 24. 9. Among methodologically rigorous books the leader is Monica Prasad, Starving the Beast: Ronald Reagan and the Tax Cut Revolution (New York: Russell Sage Foundation, 2018). Prasad, a sociologist, makes innovative use of polling data in assessing the popularity of the supply-side program. Astonishingly, she has to dedicate attention to discrediting, by means of evidence, the presumption that there was a racial element to the supply-side revolution. Her efforts in this regard suggest that a reason that the history of supply-side economics has not been treated in scholarship as expansively as might befit the most significant economic-policy revolution since the New Deal is that it did not evince racial animus. As Nancy MacLean’s notorious Democracy in Chains: The Deep History of the Radical Right’s Stealth Plan for America (New York: Viking, 2017) indicated, the mood of scholarship may well be that the free-market movement is to be studied expansively only in those areas in which it is suggestive (even if by means of dubious historical method) of such animus. Another historiographical motif is that business pressure groups’ adoption of the cause of supply-side economics conveyed the movement to the fore of policy. The effect is to minimize the intellectual-historical status of supply-side economics. See the relevant sections of Benjamin C.  Waterhouse, Lobbying America: The Politics of ­



Business from Nixon to NAFTA (Princeton: Princeton University Press, 2014) and Kim Phillips-Fein, Invisible Hands: The Businessmen’s Crusade Against the New Deal (New York: W.W. Norton, 2009). Thinness of sourcing plagues the supply-side-history section of Daniel T.  Rodgers, Age of Fracture (Cambridge, Mass.: Harvard University Press, 2012). Making a hash of evidence is Jason Stahl, Right Moves: The Conservative Think Tank in American Political Culture since 1945 (Chapel Hill: University of North Carolina Press, 2016), within which the premise of an extended criticism of Laffer, Mundell, and Wanniski is a conflation of the balance of payments with the budget deficit (p. 98). Name-calling over method is the “trickledown” section of John Quiggin, Zombie Economics: How Dead Ideas Still Walk Among Us (Princeton: Princeton University Press, 2012). A history that explicitly takes Keynesianism as “quite profound” and supply-side economics as “less a new wisdom” and a “catechism” with political “fish to fry” is Michael A. Bernstein, A Perilous Progress: Economists and Public Purpose in Twentieth-­ Century America (Princeton: Princeton University Press, 2001), 165, 167. For a history of supply-side economics, see Brian Domitrovic, Econoclasts: The Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity (Wilmington, DE: ISI Books, 2009), and for the legacy of the movement see Bruce Bartlett, The New American Economy: The Failure of Reaganomics and a New Way Forward (New York: St. Martin’s Press, 2009), and Binyamin Appelbaum, The Economists’ Hour: False Prophets, Free Markets, and the Fracture of Society (New York: Little, Brown, 2019).


In the Scope of Paul Baran

Arthur Laffer’s career in economics might be said to have begun with a speech on economic policy by the president of the United States. On June 11, 1962, Laffer was present, as an undergraduate student, when John F. Kennedy gave his Yale University commencement address in which he outlined views that had come to his attention about having a “high” monetary policy and a “flexible” fiscal policy. This speech has gone down in history as the one that telegraphed the economic policy that Kennedy soon adopted, of a strong gold dollar coupled with tax-rate cuts (the essence of what would be called “supply-side economics” in the next decade), the policy that accompanied early stages of the 1960s economic boom.1 Laffer attended the 1962 commencement, including the JFK speech (which he does not recall making an impression), because it was the graduation of the class with which he had come in at the age of eighteen in the fall of 1958. Laffer was not graduating with this original class of his. He had just completed a Wanderjahr in Germany after two years of poor grades at Yale in his sophomore and junior years, and his senior year awaited him. In that year, he would switch his major from engineering to economics. Laffer had grown up in an atmosphere of big business. He was born in August 1940 to Molly and William G.  Laffer, in Youngstown, Ohio, where his father was in a brief stint as an executive at a beer company. The © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 B. Domitrovic, The Emergence of Arthur Laffer, Archival Insights into the Evolution of Economics,




next year the family moved to Cleveland, his parents’ hometown. His father was returning to a previous employer, the Cleveland Graphite Bronze Company, to supervise a manufacturing unit. Cleveland Graphite Bronze, founded in 1919, produced bearings and bushings for the automotive industry. It expanded greatly with World War II, tripling its workforce to 7500, inclusive of hiring hundreds of women to work in its aircraft-parts division. It experienced unique union difficulties during the war, an experience that steeled William Laffer’s resolve against “right-to-­ work”—the prerogative of a worker not to join a union in a predominantly union shop—a resolve not passed down to his son. In September 1944, the United States War department took temporary control of the operations of the company—the first such takeover in Ohio during the war—as 5000 Cleveland Graphite Bronze workers went on strike. The pretext of the strike was small: the company had fired a worker after a string of violations. The animus behind the strike, however, appeared to derive from competition among unions. Leadership of the company’s workers’ major union, the Mechanics Educational Society of America (MESA), was concerned about inroads that Congress of Industrial Organization affiliates were making among the rank-and-file at the company. MESA decided to show its strength as an organization by calling a strike as American military forces were making strides in all theatres and required uninterrupted materiel shipments. By forcing the company into federal control, MESA showed that it could push it around. After two months, MESA and the company agreed to cooperate, and the government overseers left. Afterwards, the company prevailed in arbitration in the original complaint that had touched off the strike. William Laffer endured these developments, and clearly strove to incorporate their lessons into his conception of business strategy, as a member of the United States War Production Board and as Cleveland Graphite Bronze’s chief planning officer, a promotion he gained in 1943. In 1955, he was named president of the firm, which several years earlier had renamed itself the Clevite Corporation. The company increasingly specialized in defense and space-program products. It developed an acoustic torpedo for use against submarines, circuit boards for submarines, and transistors and fuel-cell electrodes for rockets. In 1959, it made a major expansion of its Waltham, Massachusetts, transistor factory, which would employ 1500 persons. In 1960, Clevite bought Shockley Transistor of Palo Alto, California, the developer of the transistor, and three years removed from its suffering the departure of the “traitorous eight” of engineers to



Fairchild Semiconductor, in the episode generally understood today as the founding event of Silicon Valley. In that year, per Fortune magazine, Clevite was the 443rd biggest industrial company in the United States, with sales of some $94 million and profits of $6.8 million. It employed 6500 persons, placing it 325th among industrial firms.2 Arthur Laffer recalls that his father approved of certain central aspects of the political-economic policy status quo that prevailed while he led Clevite and was chairman at its successor after 1969, Gould, Inc. Surely with the bitter 1944 strike experiences in mind, his father made clear that he preferred to negotiate with one representative of the employees, one union. He opposed right-to-work legislation in Ohio, which failed in a ballot initiative in 1958, on the grounds that it would lead to efficiency losses. These would derive from management’s having to scramble in making multiple labor deals with individual employees as well as perhaps several unions. Along similar lines, when the Nixon administration proposed wage-and-price controls while Arthur Laffer was working within it in the early 1970s, William Laffer expressed his preference for the policy, believing that federal ceilings on wages would temper union tendencies to ask for more. William Laffer’s career testified to widely held corporateexecutive attitudes in the post-World War II period. Given that companies had large, quasi-permanent workforces, it was easiest to deal with them as aggregates. And given that unions can over-ask for wages, benefits, and time reductions (and call strikes to jockey for position against rival unions), federal assistance in limiting their bargaining power was welcome. Also representative of big business in this era, especially concerning enterprises involved in high technology, Clevite’s revenues, earnings, and operations in good part flowed from government contracts in defense and space. With his wife Molly, William Laffer was a (Ohio Senator) Robert A. Taft Republican and thought taxes were too high. But he also felt, Laffer recalls, that there was opportunity to collect profits “beyond taxes,” even in the 1950s and early 1960s when income-tax rates on corporations were as high as 52 percent and on individuals 91 percent. This was also consistent with the business-government nexus of the period, the issue President Dwight D. Eisenhower touched on in his 1961 lament over the “military-­ industrial complex.” Government contracts as a matter of routine considered the total costs a contractor faced and provided that a profit margin remained. If costs via taxes on employee compensation and company profits were high, government contracts took these costs into account in



calculating the profit residual. The priority in these times was on contacts at and relationships with government agencies and familiarity and experience with bureaucratic procedures. Lacking these advantages as a matter of definition, startup companies faced the costs of high tax rates on their own, putting them at a disadvantage to the established competitors they sought to challenge or even topple. The Fortune 500 list of the biggest companies in the country, which first appeared in 1955 and on which Clevite regularly ranked in the 400 range, had more firms from Ohio in these years than from any other state outside of New York, Illinois, and Pennsylvania. And Cleveland had more names on the list than any other city in Ohio (in 1960, sixteen). The Cleveland in which Arthur Laffer grew up in an executive’s family remained at the apex of its business significance that had been established in the heyday of the American industrial revolution in the latter part of the century before, when John D. Rockefeller organized Standard Oil in that city, Euclid Avenue’s “millionaires row” of homes set a new standard of executive opulence, and the streetcar suburb was pioneered. Laffer’s mother Molly’s father Arthur B. Betz (who died in 1947) was a major steel warehouser in Cleveland, owning a series of sheds that kept giant pieces of equipment on call for Great Lakes freighters when their engine components failed. Arthur Betz was self-made. His first job was a runner at corporate offices of a metals firm later bought out by United States Steel. William Laffer’s father had been a brain surgeon. The family remembers his remarkable collection of diseased brains, which this Dr. Laffer would study, kept in his research space at home in bell jars with formaldehyde. Mertice Laffer, Arthur’s grandmother, was a notable suffragist, her 1916 “Votes For Women” attire now held in a Cleveland museum. Both the Betz and Laffer families were Presbyterian and came from smaller internal Ohio towns that had received German immigrants in the early nineteenth century. A Laffer ancestor’s home in Hanover, Ohio, was a stop on the underground railroad for the fugitive enslaved. In keeping with the liberal family tradition on the matter of race, Laffer’s father was the main financier of the Forest City Hospital in Cleveland (opened 1957), which served a consortium of African-American doctors seeking greater involvement in all aspects of hospital services and management. By the time of Arthur’s birth, both the Betz and Laffer families were firmly Republican in terms of their political orientation. Molly ran three times at the top of the straight-­ ticket Republican slate for the Ohio House of Representatives. The slate



lost on each occasion in this Democratic-dominant region. Twice she was grand-jury foreman for Cleveland’s Cuyahoga County. In 1952, she was a Republican National Convention alternate delegate for presidential candidate Taft. For four years, she was head of the Western Reserve Women’s Republican Club, probably the largest such organization in the country with a membership that swelled as high as 5000.3 Arthur Laffer was prepped at the Hawken and University Schools, at the latter of which William Laffer served as a trustee. In heading to Yale for college, Arthur followed the traditional course of male students prepped in the former Western Reserve, the slice of northeastern Ohio which Connecticut had claimed in colonial times and within which in 1796 Yale alumnus Moses Cleaveland surveyed a site for a city (which would bear his name leaving out the first “a”). Likewise prepped at the University School, Laffer’s father and Arthur’s two brothers had all three gone to Yale. Molly Betz had attended the Laurel School in Shaker Heights near Cleveland and finished at a school in Pennsylvania. Arthur’s selection of engineering as a major came on the recommendation of his brother and may have been influenced by the engineering focus of his father’s firm, Clevite. Of the three children in the family, all boys, Arthur was the youngest by eight years and the one distinctly affable. As he got older and it became clear that he had prospects, he and his parents thought of themselves as “a team,” advancing in the world as one might in an atmosphere of talent, ancestry, and privilege. Laffer recalls that his University School education “carried” him through his first year at Yale, in which he got Bs and Cs and two Ds for grades. But sophomore and junior years, he struggled with Cs and Ds, save a B in one of two economics courses he took over his first three years and in one math class. His father told him that he had to shape up or leave college. Father and son agreed that the son should see some of the world. Young Laffer headed off to Germany in the summer of 1961, for an office-­ clerk internship with a division of Clevite’s, Intermetall in southwestern West Germany. In Berlin that August, he saw the construction of the Soviet wall. Laffer returned to Cleveland telling his father that he wanted to take a full year in Germany. His father disagreed, but a Yale dean concurred with the undergraduate, and Arthur Laffer returned to the Federal Republic in September. He enrolled in the University of Munich and, tired of engineering, signed up for classes in Volkswirtschaft and Betriebswirtschaft, corresponding to economics and business in the American system. He found that



after several of the large lectures’ meetings, he was one of a handful of students who consistently came to class. It was an indication that the subject area was interesting him. He took two term’s worth of these courses, in German, a language in which he was becoming proficient. At the end of the spring term he returned to the United States, assuring his parents that he was ready to apply himself in college as he had not before. He went to New Haven for the commencement, saw Kennedy speak, and took summer classes at Western Reserve University in Cleveland. In his senior year, 1962–1963, he took nine economics courses and completed his Yale College bachelor’s degree with the highest grades on his record, As and Bs. In the fall of 1962, two Yale economists returned from Washington, DC after serving on Kennedy’s Council of Economic Advisers (CEA). These were Professors James Tobin as a member of the three-person CEA and Arthur Okun as a senior staff economist. In economics lore to the present day, these were the “glory days” (in President Barack Obama’s CEA chair Christina Romer’s phrase) of the CEA. Tobin and his colleagues introduced to Kennedy a “New Economics,” as dubbed by the press, and as described by Tobin as seeking “to liberate federal fiscal policy from restrictive guidelines unrelated to the performance of the economy” (specifically the “taboo on deficit spending”) as well as to “liberate monetary policy and to focus it squarely on the same macroeconomic objectives that should guide fiscal policy.” Budget deficits occasioned by temporary income-tax cuts and infrastructure spending, and monetary policy focusing on low long-term rates that encouraged capital commitments while dispensing with concern for the Bretton Woods system of fixed exchange rates and a dollar anchored in gold—these were the features of the New Economics personified by Tobin, Okun, and their colleagues on the Kennedy Council, including chair Walter Heller and staff economist Robert Solow.4 Tobin interpreted Kennedy’s Yale commencement address of June 1962 as drawing a distinction between the American business class presumptively represented by the Yale alumni and the intellectual bearers of economic ideas to whom Kennedy was striving to give proper hearing. As Tobin reflected upon it in 1974: “In his famous Yale Commencement speech in 1962, Kennedy had solicited a hostile audience to adopt, or at least tolerate, a pragmatic approach to economic policy in place of the emotions, slogans, myths, and shibboleths that had shaped business and financial attitudes ever since 1936.” Likewise it was “Kennedy’s feeling, expressed in his 1962 Yale Commencement address, that the solutions of many national problems were blocked more by irrational ideology than by



real conflict of interest and could be found by removing ideological blinders to dispassionate pragmatic analysis.” By the spring of 1962, per Tobin, Kennedy “had become intellectually convinced of the Council’s case. Innocent of economics on inauguration day, he was an interested and apt pupil of the professors in the Executive Office Building.”5 As Kennedy encapsulated it in his Yale address, according to Tobin, the vanguard economists in the halls of power in 1962 had excellent new ideas about how to achieve growth and prosperity, while business leaders had gotten stuck on economic-policy fixations. The latter group was overly concerned that there not be a federal budget deficit and that the redeemability of the dollar in gold at $35 for an ounce of gold to foreign authorities (as in the Bretton Woods arrangements currently prevailing) not be imperiled. Business leaders’ immovability on these issues was so sure that it had to come from “emotions,” “myths,” and “irrational ideology” as opposed to “dispassionate pragmatic analysis” such as put forth by the New Economists. This was particularly clear because these economists had shown, Tobin felt convincingly to Kennedy, how subtle ways to run a deficit and risk the gold dollar would yield non-inflationary growth above the postwar norm. This norm had not been particularly distinguished to begin with, Tobin noted, given that there were four recessions from 1949–1960. The accuracy of Tobin’s characterizations in this vein are open for debate. As for Kennedy’s address, it was jocose to the point of chumminess. Its main policy point was that a “flexible” fiscal policy (presumably implying deficits) could be matched with a “high” monetary policy (presumably implying a defense of the dollar), splitting the difference between the groups Tobin had pitted against each other. Tobin’s words do, however, suggest a common perception, a mentalité, that may well have held sway in the economics establishment, including in its leading section at Yale, as Arthur Laffer studied within it quite intensively as a senior. Laffer remembers that Tobin lectured in one of his classes in the fall of 1962. The topic was “Operation Twist,” the Federal Reserve program of the year before to keep long-term rates low so as to encourage investment and short rates high to manage the balance of payments. Laffer recalls finding the explanation he was given that day justifying the policy implausible. Here was a student who had come from the social context of big-­ business leadership, the stodgy crowd according to Tobin, studying Yale economics, including hearing Tobin’s lecture, and letting his quizzicality have play. Laffer remembers enjoying his senior seminar from Stanley Engerman and believes that the one low grade on his comprehensive exam at the end of his college career came from Arthur Okun.



Elective Affinities As he met success in his senior year at Yale, Laffer decided that he wanted to go to business school and applied to Stanford University’s. Stanford accepted him on the condition that his senior-year grades came in strong, which they did. In the fall of 1963, Laffer enrolled in Stanford’s Master of Business Administration program. He was marking out a path to the kind of executive career pursued by his father. But atypically for a business student, and building on the enthusiasm of the nine courses in economics he had taken the year before in college, he began taking graduate classes in the economics department. The first was an economic development class from Paul A.  Baran, who, Laffer recalls, ordinarily but not in this case detested business students. Baran was a noted Marxist and to some degree advertised himself as one of the very few open Marxists on a major American university faculty. Born in the Russian empire to a father who was a Menshevik activist, he studied in Weimar Germany and the Soviet Union in the 1920s. One of his mentors was Friedrich Pollock, a principal of the group that had recently formed the Institut für Sozialforschung (Institute for Social Research) in Frankfurt am Main and would come to be widely known as the Frankfurt School. Pollock was the member of the Institut responsible for developing its signature views on “state capitalism,” a term that had recently come into currency and referring to the methods by which large corporations collude with governments to forestall the natural processes of social revolution in advanced industrial economies. Baran avowed in 1951 that “my associations at the university of Frankfurt am Main in 1929,” inclusive of a fellowship and an assistantship at the Institut, “had a significant impact on my political thinking.”6 Baran studied and taught mainly in Germany in the 1920s and early 1930s, completing a doctorate in Berlin with a dissertation on left-wing notions of economic planning. He left the country in 1933. He came to the United States in 1939, worked in various economic-research positions for the federal government and the Federal Reserve, and was appointed to the Stanford economics faculty in 1949. He attained the rank of professor in 1951. Baran published two monographs, The Political Economy of Growth (1957) and the posthumous Monopoly Capital (1966), coauthored and finished by the fervently left-wing political economist Paul Sweezy. Both books make unmistakable Baran’s main intellectual interests in economics. His central concern was the economic “surplus,” or the



amount of production in an economy beyond the provision of subsistence needs. In Monopoly Capital, Baran and Sweezy estimated this surplus regularly to average about 50 percent of total economic output in the United States. The existence of a surplus, to Baran, was welcome, reflecting an economy acting on its capability of being productive. The problem was how it was disposed of. Typically, in the major capitalist economies, in Baran’s analysis, the surplus came to waste. Large portions of it went to such activities as marketing, padding expense accounts, and prompting consumers to buy things they did not need, as well as government-spending initiatives that propped up the very same activities or were otherwise useless or counterproductive. (During World War II, Baran had worked for John Kenneth Galbraith, whose 1958 Affluent Society expressed similar views.) As Baran and Sweezy offered in an example in Monopoly Capital, government “spending on highways has gone beyond any rational conception of social need. … The cancerous growth of the automobile complex. … would have been impossible if government spending for the required highways had been limited and curtailed as the oligarchy has limited and curtailed spending for other civilian purposes.” Automobile manufacturers promoted demand for cars to an unseemly degree, and the government accommodated it. Baran and Sweezy made similar points about education. They asserted that a central function of the provision of public schooling, via tax revenue, was to accentuate the prestige of private schooling. Corporations that generated excess revenue beyond the costs of production and sales used a portion of that excess to support their executives’ lifestyles. This support included conceding to school taxation, since mass public schooling conferred distinctiveness to executives who educated their children privately. As Baran and Sweezy put it, such maneuvering “ensures the inequality of education so vitally necessary to buttress the general inequality which is the heart and core of the whole system.” The disposition of the surplus, overall, was a tale of extensive inegalitarian waste.7 An optimal system would be one in which the surplus beyond basic needs is allocated as precisely as possible according to the investment and consumption priorities that a good society should have. Baran was certain that such priorities were not the ones the United States he observed had, but it was important that the country had a surplus. Given the existence of a surplus, the pressing matter concerned distribution, planning, and consciousness. As he wrote in The Political Economy of Growth, the ideal



“socialist government is thus placed in the position of deciding on the share of aggregate output to be withdrawn from consumption and devoted to purposes of investment (and/or collective utilization).” A good socialist government would dispense with the overdone marketing and so forth and see where surplus production could be concentrated in ways that enhanced real human flourishing, to use the current expression. Baran thought that proper socialism could involve a decrease in production, in that marketing and its likes can take the demand for production to levels better sacrificed for leisure and cultural pursuits.8 Baran’s work had the impress of political economic left-Hegelianism in its mid-modern form, such as developed by Pollock and the Frankfurt School. Production per se was not an issue. Capitalism had proven that it can be plenty productive. The question was whether it could figure out how to be productive in the right way, once basic needs were taken care of. This was the problem of “late capitalism,” a concept that Pollock and his colleagues had helped to popularize. In Frankfurt School theory, production beyond basic needs (Baran’s surplus) under the conditions of late capitalism has an unfortunate potency: it can warp the attitudes of producers and consumers alike. The ability to be plenty productive tempts producers to make fundamentally useless but superficially attractive goods and consumers to demand them. If the society in question lacks the proper attitudinal structure, people will give in to such temptations. The central matter in late capitalism, from this perspective, was therefore not achieving some level of output, but rather the quality of “consciousness” in the Hegelian sense whereby persons in a society are prone to make good choices. Baran’s economics required the development of a good (or “true” in the Hegelian terminology) consciousness within the economic-­planning establishment and if possible across society at large. Baran died in March 1964, poetically at the California home of Leo Löwenthal, a Frankfurt School member keen to demonstrate the ways in which true consciousness might be developed and lived by in the postwar American scene. Laffer came into Baran’s course on economic development, Economics 215, in the fall quarter of 1963 perhaps oblivious to this vanguard of left-­ wing economic philosophy. But as he has attested over the years, he both found Baran’s worldview fascinating and strove that academic quarter to learn and recapitulate it as well as he could. He also got along with Baran, the two taking the opportunity to speak in German and talk about Mitteleuropa. We do not possess the work Laffer produced for this course, which was probably confined to exams. As Laffer’s economics unfolded



over the next two decades, it was certainly not neo-Marxian. But the elective affinities with Baran’s economics are unmistakable. The central item in Laffer’s body of work, the Laffer curve, developed from studies of “Harberger triangles” illustrating the “deadweight loss” from an imposition of a tax. This is a topic in a latter chapter of this book. Laffer’s core idea, the beating heart of the Laffer curve, is that tax rates cause changes in behavior that necessarily involve losses. There may be gains, if the revenues used from tax collections yield utilities greater than the losses, but there inescapably are losses. The first Laffer curve as Laffer outlined it in his private notes around 1974 had immediately below it a von Neumann-Morgenstern general utility function requiring a greater than null result from any tax-rate change. The central matter in tax policy, as Laffer’s theory in this area would develop, was that there must be a clear, accurate, and perhaps even enlightened assessment of what exactly will result comprehensively in the economy from a tax change. If an increase in the rate of income tax will result in further revenue, the issue of whether the revenue will be spent well is essential. If a change in a federal rate affects collections in other federal tax jurisdictions, in state and local tax collections, and in tax systems abroad, to what effect in each case and in total is an essential issue. If a tax rate is to change, assessing its advisability must involve assessing things at a distance from the immediate economic domain of that rate, including how the taking of income and economic activity in general might shift in reaction to the change. Laffer came characteristically to inquire after what the “secondary, tertiary, and quaternary” effects might be of changes in a tax rate in one given jurisdiction across the global economy over time. This was the origin of the fabled “free lunch” of supply-side economics. If tax-­ rate cuts broadly eliminate deadweight losses, there is no trade-off between growth and tax revenues. As economist Robert E. Lucas, who admittedly had been skeptical of supply-side economics earlier in his career, wrote in 1990 several years before he won the Nobel Prize, “the supply-side economists … have delivered the largest genuinely free lunch I have seen in 25 years in this business, and I believe we would have a better society if we followed their advice.”9 Baran for his part asked what was the level of economic production and whether what was produced beyond necessities was good. The latter may be a subjective judgment, but such concerns did not immobilize him. He pursued questions of whether the economic surplus was being dealt with productively with the relentlessness typifying the fabled Marxist academic.



Laffer asked similar questions with reminiscent doggedness with respect to production as it related to tax rates. Laffer asked, for example, if tax rates go up and production suffers only a little, whether it is because owners of capital are choosing to rely more on their machines which they have already paid for to keep churning out product. If this is the case, it must be understood that the tax-rate increase has specific damaging effects of depreciating capital and making labor uncompetitive against capital. He asked if currency devaluations actually encourage imported goods, because in becoming more expensive, more of them should be produced and less consumed in foreign countries. He asked if increases in tax rates decrease the enterprise demand for money, and if therefore events such as the Great Depression typically blamed on the gold standard had at their root tax increases that prompted a portfolio-preference for gold. The parallel between the economics of Baran and Laffer was not exact. It had the aspect of an elective affinity. The motive force that drove Baran to demand that the productive surplus beyond necessities be investigated in its minutiae to see how it might be allocated in stringently enlightened fashion had a like in Laffer. Some similar basic impulse impelled Laffer to require that every tax change be interrogated down to the last details as to its comprehensive economic effects, with everything at the end run through a comprehensive utility analysis. The final expressions of the economics of Baran and Laffer differed in clear respects. Baran was a planner, Laffer an advocate of market freedom. The basic imperatives behind their economics were, however, similar. Each of these economists called for a large surplus that at every aspect of its multifariousness served to an optimal degree the respective principles that they regarded as primary. The title of Baran’s book, The Political Economy of Growth, captured the nub of the economics Laffer would develop over the course of his career. Laffer wanted to know the correlation between the two, between growth and the specific policy arrangements that are consistent with growth. His arguments for the soundness of classical monetary systems and the way he reasoned from his curve would indicate his conclusion that economic policy that is extensive or presumptuous can stifle growth. Laffer would advocate for restraint in economic policy. To Baran, unenlightened production, from expense accounts to interstate highways, pointed the way to another version of restraint. In Baran’s economics, a well-off society should be more thoughtful about what it desires to produce. Conceivably Laffer would have had few objections to these standard examples that Baran gave of the surplus wasted. Expense accounts took



advantage of tax deductibility, and the highways were government spending. Both tax deductions and government spending were, in language Laffer would develop in his economic model, “wedges” driven between the real factors of production. In his model (outlined in the 1970s), the likes of entrepreneurs seeking to make a good or service that they feel people truly want or need have a smaller pool of potential managers when executive recruits are loath to leave their expense-account lifestyle; and prospective employees for such entrepreneurs have to command a higher wage than otherwise because they are taxed to pay for government spending. Baran’s surplus and Laffer’s wedge had similar predicates. Therefore as Laffer made his transition from Yale to Stanford in the mid-1960s, he developed preferences among the various approaches of left-liberal economics. The Tobin approach—holding that business was incapable of sufficiently clearheaded thought to get economic policy right—turned him off. As Tobin spelled out quite clearly, the liberal economics profession was enlightened; if availed of, it would steer the economy clear of the policy mistakes business leaders would otherwise incur. Baran, in contrast, saw attitudinal deficiencies diffused throughout the economy and policy, presumably including the economics profession itself. Policy cooperated with primordial economic desires to create the big but poorly allocated surplus. To be sure, Baran asserted his own form of special knowledge. Planners of a Marxian bent were to examine the economic surplus, expose it for what it was, and rearrange it according to enlightened criteria. Baran was an able representative of Marxism, a doctrine that has justly come in for criticism for providing no serious account of the nature of its own enlightenment. How were Baran or Sweezy supposed to know how to allocate the surplus well once they identified it? Rarely in The Political Economy of Growth or Monopoly Capital is it more than implied or asserted that the planners will get allocation right. Why they will—what was the mechanism for getting allocation right—has been from the doctrine’s origins in the nineteenth century a fatal impossibility of Marxism. Baran’s weakness in this regard, however, was in important respects less problematic than Tobin’s lionization of progressive economic wisdom. Tobin’s claim for the unique enlightenment of economics played on strongly schematic impressions about sociological roles. People in business were not very good at thinking—they were vulnerable to being “irrational.” People in academia were intellectually gifted. A division of labor obtained in modern society in which those whose specialty was clear



thinking should shape policy, and those who excelled in the processes of business should stick to that. The argument was self-serving, arrogating to economics the mantle of policy. The justification for Tobin’s claims went unprovided. Presumably, they rested upon the nature of the professional accoutrements that the discipline had been gaining in recent years. The New Economists and their colleagues had academic degrees, avant-garde theory (continually updated Keynesianism), posts at institutions with marked social and intellectual cachet, a developed mathematical apparatus suggestive of science, peer review, a prestige hierarchy among the universities and the journals, awards and distinctions, and posts in government and the highbrow organs of journalism (Tobin wrote for the New Republic). Acutely processed professionalization itself was the warrant of economics’ enlightenment. It was a remarkable bid of afflatus for Tobin to posit that non-economists—businesspeople—involved in the economy were cursed with the burden of having to shake being transfixed by the likes of a “taboo.” The social-competitive nature of the Tobin position had no counterpart in the Baran position. Baran did not seek to insult the business community’s intellectual capabilities and in the offing make a run for power. He was more forthright. He declared that a range of standard practices in the economy was wasteful and recommended trying to think better about how to use productive resources. He was unable to ground a claim for the wisdom of Marxist planning, but this problem had dogged Marxism from the start and was probably endemic to it. If Marxism could prove its wisdom, it would have to subject itself to falsifiability (as Karl Popper had argued), and this ran counter to the agit-prop ethos of the doctrine. Baran offered no resolution to these standard criticisms of Marxism. But in no way did he seek to advance his guild at the expense of the business power elite, as Tobin strove to. Laffer, that son of a 1950s/60s-era CEO, probably concurred with Baran’s evidentiary points. Clevite maintained an apartment on 59th Street in New York, clearly a tax deduction, which Laffer remembers the family having the run of when he was a boy. And Clevite chased the comparatively easy money and oddball projects of the government-contracting leviathan while elbowing out non-connected smaller companies and startups. These things cannot have appeared to him as expressions of optimal productivity and entrepreneurship. Baran’s points were intriguing to him. They showed that such suboptimality, such waste, could be identified in a first step toward better alternatives.



In later years, Laffer would make a habit of referring to the classical healing terminology of medicine, namely primum non nocere and vis medicatrix naturae, or, respectively, “first do no harm” and “the healing power of nature.” In the outlook he developed as a pupil of business in his family’s household, and as a Stanford MBA student, Laffer probably thought that business practices could be improved. But there was a great deal of good that business did produce—the testament of postwar prosperity. Accordingly as he started to become an economist, he developed a sense of primum non nocere. And as he perceived that within the profession that he was bidding to enter numbered practitioners who claimed that they were essential to the health of the economy, he recalled that non-­ interventional processes were the essence of vis medicatrix naturae. Economics Ph.D.s typically did not hail from the homes of Fortune 500 chief executives. A belief was welling up within this academic group that American prosperity could scarcely persist without it. Indeed, if this group was to maintain size and influence, not cultivating such an impression could risk its very justification.10

The Way to the Ph.D. As Laffer continued in the MBA program, he kept taking graduate economics courses. In the spring of 1964, after Baran had died (Laffer remembers giving brief remarks at his memorial service), Laffer took his next one, on money, employment, and income, taught by Moses Abramovitz. In the 1963–1964 academic year, as he completed his business courses, he took four more graduate economics courses. He got his MBA degree in June 1965 and at that point had completed the required price-theory course sequence for doctoral students in economics and part of the sequence in the theory of income and economic fluctuations. He applied for admission to the Ph.D. program and was accepted. That summer, he entertained business job offers. The one that most gave him pause was from the New York investment bank Morgan Stanley. He faced a decision about pursuing a career in business or in academia, and he chose the latter, returning to Palo Alto for his doctoral program in the fall. Laffer recalls that the decision was difficult. The Morgan Stanley offer was a plum for a new MBA and came with a significant salary. He appreciated his father’s and in general his family’s notable success in business and did not disdain it. Moreover, he had begun to perceive that expansive new opportunities were beckoning in business. He picked up on some of them



in the job he had while a business student. He worked the night watch at the Clevite Palo Alto facility, that of Shockley Transistor. He got to know the namesake, William Shockley, the 1956 Nobel laureate in physics for his joint research in the development of the semiconductor transistor. At this juncture in his career, Shockley was following ultimately blind leads into human genetics, and he wore smarting traces of the effect on him of the departure of the likes of Robert Noyce, Gordon Moore (the Intel founders), and Eugene Kleiner (the venture capitalist) from his firm several years earlier. It was apparent that Shockley had been seeding something quite big, indeed what we now see as the vast technological revolution centered in Silicon Valley. Laffer thought Shockley a little odd, but quite interesting, and a window into a world that was coming of age. Shockley talked with Laffer about Germanium transistors as well as genetics and may have tried to recruit the young business student. The contact ended when Clevite sold the Shockley outfit to ITT in 1965. If Laffer’s time on the night watch at Shockley Transistor offered a tip into a nascent world of entrepreneurial opportunity, it also cemented this MBA student’s commitment to scholarly economics. Laffer took the job not only to earn a few dollars, but to do so while he could read in a silent and unperturbed environment. The night watch job gave him a chance to master his economic-course syllabi. The business students typically reserved their extra hours for leisure, networking, or prep-work on an entrepreneurial idea. Laffer husbanded his extra hours for his economics education. Nighttime at Shockley became his study hall in advanced economics. When he got the Morgan Stanley offer, he had come too far in acquaintance if not penetration of the field to turn away. Aside from Abramovitz, who tapped Laffer as a research assistant, Laffer took courses from his dissertation committee member Ronald McKinnon, his adviser Emile Despres, Melvin Reder, Marc Nerlove, John Gurley, and Edward Shaw. Other faculty members teaching in the department included Kenneth Arrow (the 1972 economics Nobelist) and Lorie Tarshis (Keynes’s main American popularizer and the subject of barbs in William F. Buckley’s God and Man at Yale of 1951). The written work in economics that Laffer soon began to produce with rapidity and in quantity reflected the subject matter of these courses. They also reflected thematic consolidations that Laffer made as he shaped his own economics in extended hours of study, mainly at nighttime at Shockley. The law of one price as elucidated classically in Marshall, Jevons, and Wicksell; the Samuelson price-factor equalization theorem; the Stolper-Samuelson



relative-­ price-factor model and the Rybczynski theorem; the Cobb-­ Douglas production function; the refuted (as by Ricardo) theory of absolute advantage; Slutsky’s equation; Say’s law; general equilibrium—these points of reference in the publications Laffer brought out in the years after he completed his graduate coursework at Stanford were those he had made a priority in this formative period of his economics. As he confirmed that he should opt not for Morgan Stanley but for the Stanford economics program in 1965, Laffer took a summer job in the research department at the Federal Reserve Bank of Cleveland. The department director was Maurice Mann, whom Laffer would succeed five years later as economist at the Office of Management and Budget. Laffer came up with a project for himself, writing a critical commentary on a recent article in the American Economic Review (AER) concerning short-­ term international capital movements written by Brown University economist Jerome L. Stein. This is the first piece of writing in economics of Laffer’s that we possess. We have it in its final form: as it was published in the AER two years later. Laffer brought the paper he had done at the Cleveland Fed to Stanford that fall, and one of his professors, McKinnon, indicated that with revision it was publishable. McKinnon worked with Laffer on the changes, and Laffer sent the article to the AER, which accepted it. In his first formal year as a doctoral student in economics, he had a publication forthcoming in the field’s top journal. Laffer’s “Comment III” in the June 1967 AER, on Stein’s “International Short-Term Capital Movements” in the March 1965 AER, prefigured the economic model Laffer would outline and dedicate himself to as a University of Chicago professor from 1967 to 1976. Stein’s article had produced a statistical analysis of short-term capital flows between the United States and Great Britain in the late 1950s and early 1960s. Stein inquired after the representativeness of an example in 1961 in which the “massive capital inflow into the United States was not caused by the relative rise in the U.K. Treasury bill rate,” but by “a disturbance which led many to believe that sterling would be devalued.” The passive voice rendered unclear what Stein was driving at. He seemed to be indicating that a relative rise in the British rate prompted thoughts that the pound sterling was about to be devalued. At any rate, Stein’s analysis indicated that speculation against currency devaluation determined a good portion of short-term capital flows as a rule.11



Laffer’s “Comment” proposed an alternative variable set that was responsible for the excess in short-term capital movements which Stein had attributed to speculation against currency devaluation. The major term in this set was the trade balance and the subsidiary term the money supply as it changed relative to the trade balance. If the American trade balance with respect to Britain increased, and as was typical “exporters are prone to hedge foreign accounts receivable,” excess short-term demand for dollars over pounds would develop. This real process could account, Laffer suggested, for all of Stein’s speculation factor. Laffer quoted from recent expert testimony to Congress: “It would appear, then, that virtually all of the net outflow of U.S. short-term capital outflow before 1960, and 50–60 percent of the much larger outflow of 1960 and 1961 (and indeed the first half of 1962 as well) consisted of export finance.” As Stein had used the popular perception of a devaluation play in 1961 as a pretext for his analysis, Laffer used this observation as pretext for his. He constructed a series of equations against the same data as Stein’s and found that after considering the financing needs pertaining to changes in the trade balance, his work served to “reduce the coefficients of [speculation] to a point where they are statistically indistinguishable from zero.” The argument Laffer was making would become a well-known signature of his and his close colleague at Chicago Mundell’s by the end of the decade. In the 1967 AER piece, Laffer implied that changes in the domestic economy enhancing or retarding growth in-country had consequences for the trade balance that must be precisely understood. If the economy of a country grows, for example, the country ordinarily will import more and export more, according to a schedule that corresponds to production capabilities and consumption preferences that change with income. If a country grows (or shrinks), its trade balance necessarily will change. Therefore, the trade financing needs of the economy, the bulk of which are expressed in short-term international capital movements, will change according to the differential growth rates of the countries in question as well as the schedule of production and consumption preferences against income. The essential point that if a country grows or shrinks, in particular with respect to a trading partner, capital flows financing the resulting difference in the trade balance must change accordingly. Laffer dismissed mere interest-­rate differentials as a significant factor in flows. A higher or lower rate would attract or repel creditors at the same rate as it would repel or attract borrowers. He wrote that “one may think of banks as having a



marginal propensity to invest in foreign short-term assets” and implied that borrowers were just as quick to bolt the home country for lower rates in foreign locales. Along the lines of the Sidney Alexander absorption model (as Mundell would point out to Laffer when he read Laffer’s “Comment”), differences in flows ultimately turn on differences in prospects. Growing places attract capital, and stagnant places export it.12 To Laffer in 1967, such understandings were sufficient to indicate why there may have been short-term capital flows recently between the United States and Great Britain which could not be accounted for by interest-­ rate differences. To Stein, it was evidence of speculation against a central component of the received international monetary system, a fixed exchange rate. In this first published episode of his career in economics, Laffer began to reveal the terms of the debate in which he would be engaging in political economy through the stagflation era, the President Ronald Reagan years, and beyond. He felt that the real economy normally cleared its transactions, with no residuals needing management via governmental policy. And he felt that domestic growth differentials usually accounted for all the changes in international capital flows and trade as well. Such changes did not bespeak faultiness in a fixed-exchangerate system. Stein’s article had a Keynesian style. It indulged the idea that the current system was unstable. Excess and speculation came to the fixed-­ exchange-­rate world as a matter of course, in this case revealed by the way money moved among major countries over brief periods of time. The implication was that the movements were wasteful. A system that did not occasion speculation in capital flows would have capital allocated in full toward the real needs of useful production (a point reminiscent perhaps of Baran). The philosophical supposition of Keynesianism is that economies when left alone are unstable and clear below the level of maximum useful productivity. Economies therefore need therapy (in classical Keynesianism, in the form of innovative government-spending projects) in order to achieve their potential. Stein’s article implied, similarly, that the current monetary system was wasting resources and that something had to be done by way of intelligent exogenous reform to change it for the better.13 Stein was joining a pan-economics effort, as it would clearly become by the late 1960s, deeming Bretton Woods as having outlived its usefulness and needing to be dispensed with for something more contemporary. Fixed exchange rates and an anchor in gold—these central attributes of Bretton Woods derived from the haphazard monetary system of the



primitive industrial economy prior to the Keynesian revolution—they could not abide modern sensibilities in professionalized economics. From Milton Friedman to James Tobin to Paul Samuelson, among numerous others, top economists in the 1960s fashioned a consensus that exchange rates should float and gold dropped as a systematic unit, fulfilling Keynes’s notorious 1923 remark that the gold standard was a “barbarous relic.” Identifying one of the umpteen inefficiencies in the fixed-exchange-rate, gold-anchored system as Stein had in 1965 in the AER, he contributed yet another piece of evidence that it was time for the international monetary system to grow up. Economists had at first welcomed Bretton Woods. As Robert Leeson reported in his study of the mass coalescing of anti-Bretton Woods sentiment among economists in the 1960s, Ideology and the International Economy (2003), in a 1945 poll of members of the American Economic Association 90 percent of the respondents approved of the adoption of the protocols. Yet as Friedman reflected in 1967, by that point, in his estimation, 75 percent of economists favored flexibility in exchange rates, up from his guess of 5 percent a generation before. As Leeson recounts, by the mid-1960s, the new majority for flexible rates was hardening into a movement. It had become typical for economists to urge the adoption of flexible rates. Leeson adduced a joint statement made in 1966 by Friedman, Harry Johnson (Laffer’s future rival at Chicago), future Nobelists James Meade and Jan Tinbergen, and secular-stagnation pioneer Alvin Hansen that griped that flexible exchange rates to date had “received little attention in official circles” and that intellectual momentum demanded otherwise. He quoted Harvard University’s Gottfried Haberler’s claim that flexible rates were “the only alternative” to more onerous national capital controls, as well as Tibor Scitovsky’s assertion that flexible rates expressed the “greater faith—or hopes … of most of the academic specialists today.” (Scitovsky was a future dissertation-committee member of Laffer’s at Stanford.) And there was Princeton University’s Fritz Machlup, who told Friedman of his intention “to form another group. The time has come, we think, to make a more aggressive push towards greater flexibility of exchange rates”—indicating a plan to rally academic experts in this area to influence members of Congress and officials at the treasury. From a theoretical perspective, it is ascertainable why economists in both the monetarist and Keynesian traditions would be interested in clearing away the gold/fixed-exchange-rate system re-codified in 1944. Monetarism emphasized monetary quantities, specifically as opposed to



the price of money. A fixed price of gold is just that, a price, as is an exchange rate. Quantity targeting, to be true to itself, has to require price discovery in exchange rates and the gold market. Friedman touted flexible rates as a central plank of his free-market vision. Non-flexible rates represented government price-fixing. Political conservatives such as Arizona Senator Barry Goldwater adopted the flexible-rate cause on account of such justifications. As for the Keynesians, domestic macroeconomic management, specifically through the running of governmental budget deficits, could only find an obstacle in the requirement to maintain a currency par, much less gold convertibility. There was less maneuverability under such a regime to pursue budget policy in response to domestic democratic imperatives. As Samuelson put it to president-elect Kennedy in 1961, “it would be unthinkable for a present-day American government”—underscore in the original—“to deliberately countenance high unemployment as a mechanism for adjusting to the balance of payments deficit. … It is equally unthinkable that a responsible Administration can give up its militant efforts toward domestic recovery because of the very limitations imposed on it by the international situation,” meaning the Bretton Woods pars. Kennedy had just announced that he wanted to maintain the commitment to Bretton Woods, and this was the brushback he got from Samuelson. Kennedy kept to gold and fixed rates throughout his term in office.14 In a certain sense, the consensus developing against gold and fixed rates in the 1960s represented a rapprochement between competing traditions, between the right and the left. The deregulating right and the big-­ government left thought gold and fixed rates alternatively intolerable and constricting. But an attitude of superiority was always there not far from the surface. It may well have been the basis of the rapprochement. George Stigler, that darling of certain segments of the libertarian right for his work exposing the flaws of regulation, spoke at a conference in 1966 of how he was: interested in how weak the criticisms of flexible exchange rates were. … the opposition is inarticulate and unrationalized. … From this I deduce that opposition to flexible exchange rates is not based on analytically defensible criticisms of how the economy would behave. Rather, the opposition rests upon an instinctive and possibly atavistic belief, on the century-old history of the gold standard, that a fixed price of gold serves to discipline dangerous fiscal and monetary tendencies.



This was getting close to Tobin’s referring to the irrationality of business executives. Here those interested in seizing, respectively, the mantle of fiscal policy—Keynesians—and monetary policy—monetarists—found not merely a common adversary, but a common subject of their condescension, advocates of the gold-based monetary system. Examples of such willful condescension from academics accompanied the downfall of Bretton Woods in the late 1960s and early 1970s at each turn.15 Laffer, much to the contrary to all this, and perhaps with a dose of naïveté, held that nothing was wrong with the status quo. As he indicated in the Stein piece, changes in short-term capital flows reflected normal economic processes in which markets were clearing. Moreover, his article indicated, the unalloyed good of economic growth produces effects which themselves must not be mistaken for what they are not. As Laffer and Mundell would challenge the flexible-rate consensus increasingly furiously in the coming years, growth cannot produce problems in a classically arranged international monetary system. The only thing growth can do is discover new ways in which that system works well. This belief had a corollary, one that would move to the center of Laffer’s economics and the supply-side revolution at large. This was that permitting a domestic economy to grow by its natural processes was the proper paramount objective of policy and involved no trade-offs in the international domain and no courting of destabilization or disequilibrium. Laffer’s economics has gone down in lore as a major contribution, such as it may be, to the modern conservative tradition. This is notwithstanding any affinity Laffer derived from the Marxism of Paul Baran, and setting aside the kinds of conservatism represented by such figures with whom he disagreed, including Friedman, Stigler, and Goldwater. The particular ways in which Laffer was a conservative began to become apparent while he was in graduate school. The “Comment III” article cited a number of observers in scholarship and government alike who had been pointing out since the 1950s that undulations in the trade balance inspired changes in the rapid movement of money among trading partners. These observers were, rather clearly, not making their claims in the service of forwarding new intellectual paradigms or to urge a reform derived from such paradigms. They were looking for ready practical answers from evidence. At this first moment of his career among professional economists, Laffer cited sources striving to testify to plain meaning, as opposed to intellectualized economists preparing foundations in their case studies for new theories and new policy structures imagined from them.



The core principle of conservatism is respect for the accretions of the past (which is consistent with the assumption behind primum non nocere). Laffer provided an example of this respect in his first piece of scholarship. As for why he may have been a conservative at this point in time, and for all his rapport with Baran, this matter must remain speculative. The pride he had in the big-business environment of Cleveland in which his family played a leading role may have done its part. And as he crammed his economics in at Yale his senior year as he finally got serious as a student, there was something he found off-putting in those such as Tobin who exuded attitudes about the fundamental stodginess of businessmen and the clearheadedness of the right type of intellectuals. In the journals in 1967, the only change for which Laffer was conceivably advocating was that of economic growth. Such a change, according to his calculations, would cause no problems. Laffer took five more economics courses in 1965–1966, one fewer than before his MBA, and passed the economic-fluctuations (or macro) comprehensive exam that remained after he had passed his first in price theory (or micro) at the time of his business degree. He was all-but-dissertation in residence at Stanford in 1966–1967, working on his dissertation on the topic in which he was currently publishing, short-term capital flows. His advisor was Despres, the former Harry S. Truman administration official whose work in the 1930s for the Federal Reserve had analyzed the enormous darting capital movements among countries during the international crisis of the Great Depression. In the academic year of 1966–1967, his fourth year studying graduate economics at Stanford and in anticipation of his forthcoming June publication in the AER, Laffer went on the job market. He got tenure-track offers from Princeton University and the University of Chicago. The latter institution had recently hired as a full professor the author of a paper, to be published in 1968, which Laffer had enjoyed profoundly and whose economics he found exceptionally congenial to his own. This economist was Mundell, and the paper “Growth and the Balance of Payments” was delivered probably for the first time as a lecture in Switzerland in 1965. Contra the growing consensus, it argued, via novel geometry, that growth only solidifies the given payments system. Laffer went to Chicago with the unsigned offer in hand and after meeting the admittedly personally quirky Mundell for the first time made his decision. Laffer told Princeton no and Chicago yes. His term on the tenure-track on the economics faculty of the University of Chicago Graduate School of Business would start in the fall of 1967.



Notes 1. A history of the 1964 tax cut is Lawrence Kudlow and Brian Domitrovic, JFK and the Reagan Revolution: A Secret History of American Prosperity (New York: Portfolio, 2016). 2. For details on Clevite/Cleveland Graphite Bronze from the 1940s–1960s, see the relevant entries in the Encyclopedia of Cleveland History, https://; Fortune, July 1960, p. 146–47. 3. “Forest City Hospital,” Encyclopedia of Cleveland History; Golden Jubilee 1917–1967 South Euclid, City of South Euclid (Ohio), 1967, p. 70. 4. Christina Romer, “A Look Inside the Economic Report of the President,” Feb. 11, 2010,; James Tobin, The New Economics One Decade Older (Princeton: Princeton University Press, 1974), 10–11. 5. Tobin, The New Economics One Decade Older, 5, 24, 52–53. 6. Paul A.  Baran, “Biographical Material Presented to U.S.  Secretary of State,” Biographical Material, Paul Alexander Baran Papers, Stanford Digital Repository, p. 4; see also Paul M. Sweezy and Leo Huberman, eds., Paul A. Baran: A Collective Portrait (New York: Monthly Review Press, 1965); for Frankfurt School history, see Martin Jay, The Dialectical Imagination: A History of the Frankfurt School and the Institute of Social Research, 1923–1950 (Boston: Little, Brown & Co., 1973). 7. Paul A.  Baran and Paul M.  Sweezy, Monopoly Capital: An Essay on the American Economic and Social Order (New York: Monthly Review Press, 1966), 171–74. 8. Paul A.  Baran, The Political Economy of Growth (New York: Monthly Review Press, 1957), 268. 9. See for example Arthur B.  Laffer, “The President’s Tax Plan,” Laffer Associates, May 8, 2017, p.  6; Robert E.  Lucas Jr., “Supply-Side Economics: An Analytic Review,” Oxford Economic Papers 42, no. 2 (April 1990), 293, 314. 10. Arthur B. Laffer, Vis Medicatrix Naturae (The Healing Power of Nature): A Supply-Side Guide to Fiscal Policy (Nashville, Tenn.: Laffer Associates, 2019), 185. 11. Jerome L.  Stein, “International Short-Term Capital Movements,” AER 55, nos. 1–2 (March 1965), 43. 12. Arthur B.  Laffer, “Comment III,” AER 57, no. 3 (June 1967), 557, 559–60. 13. For a discussion of the similarities between Freudianism and Keynesianism in their respective domains, see Brian Domitrovic, “A Civilized Relic,” eh. net, November 2010. 14. Kudlow and Domitrovic, JFK and the Reagan Revolution, 58. 15. Robert Leeson, Ideology and the International Economy: The Decline and Fall of Bretton Woods (New York: Palgrave Macmillan, 2003), 50–51, 63.


“Growth and the Balance of Payments”

When Laffer visited the University of Chicago in the spring of 1967 to consider accepting its offer, he gave a paper in Mundell’s economics “workshop” (in the Chicago economics parlance) on international trade. In attendance were professors and graduate students. Mundell inquired after the first page of Laffer’s manuscript, “International Financial Intermediation.” The author responded by beginning to explain the topics treated on page 1. Mundell, in his super-soft voice, interrupted, saying he meant the page before, the title page. Save the author’s name on it were the three words, “International Financial Intermediation.” Mundell asked what the first part of the first word meant, and the author replied, “between.” He asked what both the first and second parts of the third word, “inter-” and “mediation,” meant. The author conceded, “between.” Mundell luxuriated in his point. There were three “betweens” in three words as the title of the paper. Titters came from the audience. These are Laffer’s recollections of that day. They include as well Mundell’s permitting clouds of chalk dust to settle on his coiffure and tying up his trench coat not with the twill khaki belt it must have come with, but with a piece of clothesline. Laffer saw the affection that welled up in the students in particular as Mundell put on his show. Laffer had come well-­ disposed to Mundell on account of his “Growth and the Balance of Payments” paper. Now he knew he was going to like him. This was the opening act of the “Mundell-Laffer” team, as Jude Wanniski © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 B. Domitrovic, The Emergence of Arthur Laffer, Archival Insights into the Evolution of Economics,




would call it in the 1970s, as the three (Wanniski included) were seeding the supply-­side revolution in intensive political and journalistic work in Washington and New York. Wanniski would refer to the two economists, respectively, as “the modern Walras” and “a modern Say.” Mundell’s political economy emphasized equilibrium, and Laffer’s growth.1 Mundell was thirty-four years of age when Laffer met him at Chicago in 1967. He had been recruited to the university two years before with a tenured full professorship. Mundell had been a Wunderkind in international economics since his all of two years as an industrial economics doctoral student at the Massachusetts Institute of Technology, studying under advisor Charles Kindleberger. His 1956 dissertation on trade and capital movements, and his subsequent work at junior postings at Stanford, a Johns Hopkins University Institute in Italy, McGill University, and the International Monetary Fund and the Brookings Institution in Washington, DC, resulted in a slew of articles in the top journals. The two articles cited in the announcement of Mundell’s Nobel Prize in economic sciences in 1999 date from this first part of his career. The one from 1961 concerned “A Theory of Optimum Currency Areas,” an article widely understood to have provided theoretical basis for the euro. The other from 1963 justified a policy mix under fixed exchange rates, such as John F.  Kennedy had recently recommended, of monetary policy aimed at stabilizing the currency and fiscal policy at spurring domestic growth.2 The latter paper’s publication in the Canadian Journal of Economics and Political Science was apt. Mundell himself was Canadian, born and raised in Kingston, Ontario. Canada was, moreover, a useful example of a representative “small country,” the term often used in economic models, that has to be a price taker in international transactions, including especially those concerning the attraction (or repulsion) of capital. As Mundell wrote in the Canadian Journal: I assume the extreme degree of mobility that prevails when a country cannot maintain an interest rate different from the general level prevailing abroad. This assumption will overstate the case but it has the merit of posing a stereotype towards which international financial relations seem to be heading. At the same time it might be argued that the assumption is not far from the truth in those financial centres, of which Zurich, Amsterdam, and Brussels may be taken as examples, where the authorities already recognize their lessening ability to dominate money market conditions and insulate them from foreign influences. It should also have a high degree of relevance to a



country like Canada whose financial markets are dominated to a great degree by the vast New York market.

The article emphasized perhaps the central point of the economics of Mundell’s prolific period of the late 1950s and the 1960s. This was that, as Mundell’s student Rudiger Dornbusch would later put it, there was a “tyranny of capital mobility” in the world economy at that time. Sovereign policy choices in the Bretton Woods milieu were not so sovereign. They courted reactions from outside the sovereign space—from foreigners— that proceeded according to their own native dynamics had significant consequences. International capital flows were the main example. They “voted,” as it were, on every policy choice. Sovereigns disregarded this reality at their peril.3 Mundell was at once serious and droll about these issues. “He always had an undeniable streak of the enfant terrible” (Dornbusch again), including after he had been an enfant in the 1950s and 1960s. At the center of each of his numerous top-journal articles was unique equation-­ derived geometry (the exception was the optimum-currency article, which was all in prose) that reoriented the question under investigation as a matter of course. Bounding these material sections of his articles came diverting observations, often quite cultured paradoxes, for example the following from a lecture in Montana in 1968 on the collapsing international gold standard: I can think of few places in the world where the subject of my remarks would appear to have less relevance. The “Big Sky” country reminds one of the vast continental dimensions of the United States and how closed the United States economy really is compared to other countries, except for Russia and China. At Billings airport there is a prominently displayed quotation by Herbert Hoover which says that the metal resources of Montana exceed those of all the known resources in the Soviet Union. If that were true (and I very much doubt it!) Montana itself would have to be a very open economy in order to profit from them. One can easily imagine the problems this state would have if the financial apparatus in the United States broke down. But the position of Montana vis-à-vis the United States is not very different from that of many nations in the world confronted with the threat of international financial breakdown. So, on second thought, Montana is not such an impossible place to speak about international monetary disorder.



Mundell could be puckish as well, teasing Milton Friedman on the Chicago faculty that in endorsing flexible exchange rates, “Milton, the trouble with you is that you lack common sense,” or calling on overfilled teacups as metaphors for the international monetary system. His IMF supervisor Marcus Fleming called his wild-looking, though surely quite geometrically exact graphs of functions which looked as if they were spinning like pinwheels “Mundell’s mandalas.” Mundell could well have designed his economics graphs for the journals, at this moment in the 1960s, in part to echo the popular-culture rage for the iconography of India.4 The Mundell-Laffer team, as it emerged on the national political-­ economic scene in the next decade, had in it, in certain respects, personalities that were two of a kind. As Mundell and Laffer offered a common economics in the supply-side years, the playful confidence that both exhibited before academics, political figures, journalists, and the public alike did not belie a feeling on their part that their endeavor was quixotic. They were confident, in particular that they were actually going to win, and not in some debate in the field, but in terms of policy implementation, and as such they were not above being alternatively jocular and lordly about it. Laffer had acquired brashness as a prepper in Cleveland, and he has long referred to himself as a protégé of Mundell’s. A characteristic of Mundell’s that Laffer probably let shape him was a rather supreme self-confidence that often manifested itself in boyishness. Both of these enfants terribles consistently exuded a belief that their abilities in advancing the claims of good economics in the cause of civilization were on the extreme edge of the first rank. As of the fall of 1967, Laffer was Mundell’s economics colleague at the University of Chicago. A note should be made of the nature of the economics faculties at this institution at this time. Laffer was on the economics faculty of the Graduate School of Business (whose dean was George Shultz). Mundell was on the economics faculty of the Social Sciences Division. This was the larger group, with upwards of twenty members to the business school’s perhaps ten economists, among other professors on that faculty in fields ranging from finance to accounting. On the social sciences economics faculty were Mundell and such members as Friedman, Harry Johnson, Arnold Harberger, and Theodore Schultz. On the business school economics faculty were George Stigler, Merton Miller, and Eugene Fama. Economists populated other units within the university. F.A. Hayek had been at the Committee on Social Thought and Ronald Coase was at the law school. The social sciences and business economics



faculties worked as one unit in important respects, including in certain committee work, matters of voting, student advisement, and participation in the workshops. Laffer’s position with the university began in the fall of 1967 and was tenure-track. The rank of this position was possibly “instructor” at the beginning, though the official University announcement of new appointments from late in 1967 listed Laffer as “assistant professor.” As he came on the Chicago faculty, Laffer lacked the terminal degree, the Ph.D. He was “all but dissertation,” A.B.D. by the popular acronym, having completed his Stanford coursework and comprehensive exams and needing one more partial requirement to get the doctorate, a dissertation approved by the Stanford authorities.5 It was within the normal course of operations for universities at this time, and to an extent these days in the twenty-first century, to offer a promising advanced graduate student a tenure-track position, on the understanding, possibly made explicit, that the doctorate will be completed in short order. Often when such hires are made it is because of the degree-granting cycle at the doctoral institution. After a dissertation is approved—after all the specified academic authorities according to the university regulations have signed it—typically there is one further bureaucratic step that the candidate has to take. This is to fill out forms and apply for the degree. The degree will then be conferred at the next commencement, which could be six months away. In the meantime, one starts a tenure-track job without the Ph.D. This is not what happened in Laffer’s case. His dissertation on private short-term capital movements, an expansion of the theme he had explored in his June 1967 AER article, may well have been completed to his adviser Emile Despres’s satisfaction, and perhaps to that of his other readers, Ronald McKinnon and Edward Shaw. The dissertation, however, did not have the signatures on it yet. If it had, Laffer could have applied for the degree and waited for it while a Chicago faculty member, getting it at the next Stanford conferring of degrees, of which there were upwards of four each year. Per Stanford regulations, he had five years from his comprehensive exams, the last of which he took in 1966, to complete the dissertation with the approvals.



Brookings and the Dollar Crisis Laffer took his first year as a faculty member at the University of Chicago, 1967–68, on leave, accompanying his doctoral adviser Despres to the Brookings Institution in Washington, DC.  Brookings Senior Fellow Walter Salant had invited Despres to come to the Institution to work on a theme he, Despres, and Mundell’s adviser Kindleberger had written about to distinct effect the year before. In a long (four-page) signed article in London’s Economist magazine of February 1966 called “The Dollar and World Liquidity—A minority view,” these authors disputed a rising consensus regarding the United States balance-of-payments position.6 This consensus had it that American trade and capital deficits were sending far too many dollars abroad for the convertibility of the dollar in gold to remain credible. Despres and his co-authors countered that no crisis in the dollar’s convertibility was brewing. Dollars were going abroad to stay there and perform key functions as dollars. The huge financial “intermediation”—Mundell would have chuckled—services represented by the global primacy of the dollar were the basis of the big foreign dollar demand. If there was a “dollar glut” (a common term in international economics circles), it showed not incipient claims on gold, but that the world over, the dollar retained preferability as a transactions medium. Despres and his co-authors made a Shakespearean argument about the notion that flows of the dollar from the United States indicated a crisis. Such talk was sound and fury signifying nothing. And they laid blame squarely: Such lack of confidence in the dollar as now exists has been generated by the attitudes of government officials, central bankers, academic economists, and journalists, and reflects their failure to understand the implications of [the] intermediary function. Despite some contagion from these sources, the private market retains confidence in the dollar, as increases in private holdings of liquid dollar assets show. Private speculation in gold is simply the result of known attitudes and actions of governmental officials and central bankers.

In this interpretation, to use the venerable Marxian language, the crisis was merely superstructural. The real economy was getting along fine in current arrangements. Any disruptions there were, in the dollar-gold market, came from speculators who took advantage of unnecessary moves



made by policymakers in places like central banks and treasuries whom scholars and their ilk had goaded on to act as if there was a crisis. In the twenty-first century, even those audiences well-attuned to global affairs may have difficulty comprehending the fuss over the dollar, gold, and the international monetary system that came on thick in current-­ events discussion in the 1960s. The international monetary system is a boutique issue today. Impassioned discussion about it is the stuff of the margins. On the right, “cranks” confer in online conventicles or at parochial conferences about the gold standard and central banks. Judy Shelton, a close friend of Mundell’s and a critic, as she has put it, of the current “anti-system” of monetary arrangements since the abrogation of the gold standard, attracted letters of condemnation from economists and Federal Reserve officials alike when President Donald J. Trump nominated her in 2020 to the Federal Reserve Board. (A Washington, DC “beltway” adage since the 1970s has it that if you bring up the gold standard in policy circles, you lose your reputation.) On the left, protesters march against the International Monetary Fund (IMF) and similar institutions as instruments of “austerity” and “neoliberalism.” Otherwise the circumscribed professional communities of the international monetary system keep up with outlining a vision for the system, how the currencies of emergent hegemons such as China should be weighted in the official accounting arrangements and so forth. Circumscription within the broader domains of economics, political economy, and public policy is a central aspect of this issue in contemporary times. To say that the international monetary system is a premier pressing issue today is obviously incorrect.7 This was not so in the 1960s. At that time, and increasingly into the early 1970s, the international monetary system bid to become the central issue in economics at large. It was necessary that the international monetary system be in manifest crisis for this bid to take place. If that system was characterized by stability and “automaticity” (economics parlance that Mundell used in this context), indeed if these characteristics made that system recede to the background in the face of dramatic positive economic developments such as widespread global economic growth, that system had no great claim on attention, other than that necessary to ensure that one does not fix what is not broken. If, however, the system was flawed, and its flaws were coming to the fore wherever money could be found in the global economy, the issue was pressing, the need for reform was urgent, and the attention of economics had to turn toward the matter.8



Whether there was a crisis for real, or whether the whole issue was phony, was the matter laid out in the Economist spread. Despres et  al. made rather clear that they thought the issue was superstructural. In labeling their work “a minority view” and offering a response, the editors of the Economist presumed to speak for many in insisting that the issue was fundamental. They wrote that “it may be in the end that jolting the dollar as well as the pound off their present pegs turn out to be the one way in which radical moves to an international monetary order can be launched.” In general, economics endorsed the proposition that the international monetary system was in crisis in the latter 1960s and the early 1970s. Since the Bretton Woods conference of 1944, and arguably since large gold inflows to the United States became routine around 1934 (they corresponded to the intensifying war in East Asia and the clouds of war and totalitarianism in Europe), the international monetary system had had two main distinguishing characteristics. The first was that rates of exchange were largely fixed. Typically, minor currencies maintained a fix against a major currency, and typically those major currencies maintained a fix to the US dollar. There were devaluations and revaluations and flouters and non-­participants here and there, but the approximation of the ideal type was fairly full. There were, globally, functionally fixed rates of exchange among currencies to the dollar. This system was formalized at Bretton Woods. Participants in the IMF, the main institutional creation of the conference, had to get permission not to maintain their currency on the open markets within 1 percent of par to the dollar. The second characteristic was the dollar’s anchor in gold. Since 1934, the United States had been reliably pledging to foreign monetary authorities to redeem on demand the dollar in gold at the rate of $35 per ounce. The United States had credibility on this score chiefly because of its immense gold stock. In 1933, the United States confiscated its own inhabitants’ private gold holdings, in exchange for US currency at the rate of $20.67 per ounce. This motherlode formed the basis of the United States Bullion Depository at Fort Knox, constructed in 1936 and taking in the bullion from the domestic confiscation and the big flows from foreigners as the war clouds got worse. There was so much gold in United States’ possession, there was a “gold overhang,” as it was called. The United States could print many more dollars and not see redemption requests threatening its stores for some time. As with fixed rates to the dollar, Bretton Woods formalized that foreign authorities had rights to US gold at $35 per ounce. Fixed exchange rates to the dollar and the dollar



anchored in gold, with the IMF available for countries experiencing temporary difficulties with the par band: this was the Bretton Woods monetary system. The agreement that came out of the conference blessed the status quo and made the superaddition of the IMF. The economics literature on the nature, implications, and experience of the Bretton Woods system as it was implemented and operated after 1944 had become voluminous by the mid-1960s. The first note of crisis came in the 1950s, when the gold overhang got wiped out, replaced by a dollar overhang, soon called the glut. The US treasury department was particularly concerned, because it bore institutional responsibility for the gold stock. Public officials, including the president, expressed interest in stemming the gold outflow and improving aspects of the balance of payments. This term, a protean one, technically is an identity, its constituents summing to zero. In colloquial usage in this era, the balance of payments referred to the amount of dollars going out of a country, the United States in this case, compared to foreign currencies coming in. If the supply of dollars going into foreign accounts in the normal course of economic transactions, to settle trade or for investment for example, exceeded the flow of foreign currencies into American accounts, the total potential claim on the American gold stock would go up. In the 1950s, this total did go up. Correspondingly, the United States’ gold position in absolute terms, as well as relative to the size of its economy and currency float, went down. In October 1959, economist Robert Triffin of Yale University testified to Congress that the Bretton Woods system necessarily required the United States to send more dollars abroad than could possibly be demanded back in turn by domestic holders of foreign currencies. In remarks to the Joint Economic Committee, he asked his fundamental question: “Does the evolution of our international reserve position suggest that we might have difficulties in maintaining the free convertibility of the dollar at its present value in terms of gold and foreign exchange?” Triffin proposed that because the Bretton Woods system emphasized foreign currencies’ maintaining a par value against the dollar, there was a very large demand for dollars for foreign currency-reserve accounts. This demand made it impossible for the United States to maintain a reasonable gold cover for the dollar. At some point in the near future, the United States could even run out of gold because of the enormity of foreign dollar holdings. Triffin proposed that international institutions such as the IMF



come up with a new accounting device into which foreigners could transfer their dollar reserve holdings.9 The official gold stock of the United States kept going down in the years after Triffin’s warning. The Yale professor appeared to be vindicated. A race was on within economics and the policy establishment to decide what to do about the matter. The consensus view was that a major reform had to take place, and it would happen with or without design. One position was to maintain “benign neglect” and see what evolved in the course of events. Milton Friedman’s advocacy of floating exchange rates, repeated for a popular audience in the 1962 book Capitalism and Freedom, lent credibility to the idea of letting Bretton Woods expire. This would be the eventual result. American redemptions of the dollar in gold and, for the most part, fixed exchange rates went away for good over the five years from 1968 to 1973. The Despres, Kindleberger, and Salant position in The Economist in 1966 perhaps appeared to be an endorsement of benign neglect. This was not quite so. Benign laissez-faire might have captured their view more precisely. Their position was that the excess demand for the dollar was, in the natural operations of the economy, unlikely to result in large demands on the American gold stock. As they wrote, “the idea that the balance of payments of a country is in disequilibrium if it is in deficit on the liquidity … definition is not appropriate to a country with a large and open capital market that is performing its function as a financial intermediary.” They pointed out that foreigners, in particular western Europeans, preferred to hold dollars in many cases over their own currencies because there were greater investment and savings-vehicle opportunities in the denomination of the dollar. Europeans had a “liquidity preference,” in the Keynesian language, for the dollar. The proposition that they were going to switch to gold en masse did not take into account the reasons Europeans preferred to accumulate comparatively large amounts of dollar holdings. Despres, Kindleberger, and Salant advised that nothing need be done in the current circumstances. The system would survive, indeed continue to thrive. In the benign neglect view, in contrast, doing nothing would force an organic reform. Despres et  al. believed that the gold outflow would arrest itself of its own accord. As they wrote of the American gold, if Europeans “took it all, which is unlikely, the United States would have no alternative but to allow the dollar to depreciate until the capital flow came to a halt, or, much more likely, until the European countries decided to stop the depreciation by holding the dollars they were unwilling to hold before.” But in the estimation of these three economists, Europeans were



willing to hold dollars as opposed to gold. At the minimum, they concluded, “It seems evident that European countries would cease conversion of dollars into gold well short of the last few billions.” Salant brought Despres to Brookings in 1967 to continue work in this vein, and in tow came Laffer. Salant and Despres were going to work on their “financial intermediation” thesis. They were to explore how American comparative advantage in providing banking and financial services to foreigners, including in foreign locales, gave a mistaken impression of a dollar crisis. They would further their work into the foreign liquidity preference for holding dollars, especially how this preference indicated that fixed exchange rates and the dollar anchor in gold constituted a monetary system that was not in disequilibrium. Laffer’s role was to assist in this endeavor and proceed in his own economics along the lines of his AER article and his dissertation on short-­ term capital flows. As he had argued in the AER, such flows had offered another false opportunity (taken in this case, in Laffer’s view, by Jerome Stein) to see instability inherent in the current fixed-exchange-rate system. His dissertation, as we have it from its 1971 submission to Stanford, was an expansion of his AER “Comment.” It increased the scope of the historical material, going back not just to the 1950s but to 1820, and provided a model explaining short-term capital flows within the framework of trade credit. Less explicitly than in the AER, it showed that short-term capital flows had little to do with exposing inefficiencies in the monetary regime. This dissertation may have been finished by the time Laffer got to Brookings. This was Laffer’s (and Despres’s) position when Laffer’s Ph.D. controversy came to a head in 1971, a subject discussed here in a subsequent chapter. Other topics than the focus of the dissertation captured Laffer’s interest and attention in the year on leave. These topics had to do with the stability of the given monetary regime in broad terms, beyond the particular way this stability was illuminated in short-term capital movements. The Salant-Despres work at Brookings barely got a chance to begin in 1967–68 and never reached fruition. Despres took sick during the year and became incapacitated. The large work on financial intermediation as a driver of dollar outflows from the United States, the follow-up to the Economist article, had to go by the wayside. Laffer, for his part, continued apace in the general topic area in his unique fashion, unguided by Despres. In January 1970, Brookings held a conference on international capital



movements that presented the thrust of the discussion Salant and Despres had hoped to lead two years before. The paper Laffer presented at the conference, and Salant’s response to it, indicates the lines of research that Laffer had explored during his time at Brookings.10 Laffer’s January 1970 paper was called “International Financial Intermediation: Interpretation and Empirical Analysis.” It had probably begun life as the paper Laffer brought to Chicago in the spring of 1967 which prompted Mundell’s teasing about the three “betweens.” The paper began by noting that the 1966 article by Despres, Kindleberger, and Salant was “now classic.” One of the chief reasons was its contention that “persistent deficits” within the current and capital account terms of the balance of payments “may not be an indication of a disequilibrium position in the sense that the dollar is overvalued relative to other currencies. Instead, these deficits may actually be necessary for a healthy world economy.”11 Laffer proposed a model that would test the validity of “IFI,” or international financial intermediation. His first observation was that equilibrium analyses of the balance-of-payments can choose one of three terms as the “residual” which must be accounted for. In “accepted orthodoxy,” the residual is the sum of “monetary movements” that take the balance to even. Presumably these were the gold flows needed to settle the world’s transactions with the United States. The second possibility is that capital flows are the residual. “The IFI hypothesis fits into this second class of models,” the premise of which is that foreign investors have a liquidity preference for the dollar. The third potential residual is the current account, expressing the trade balance, which Laffer’s paper would explore. Laffer noted that “in a fully specified complete system, it should make little difference which account is the residual.” Laffer was implying that focusing on residuals that had no strong claim on meaning—there is no residual in a balance—was necessary to stoke the sense that the payments system was in a constant state of crisis. Laffer offered, as the basis of his model, a three-term equation for the international demand for money. That demand was a function of each country’s income modified by the demand for money at each level of income, the world price level, and an interest-rate term. The aggregate demand-for-money variable represented the preferences of all countries of the world. The supply of money, however, in Laffer’s ideal-typical model, had one source, the United States. Equating the global demand for money



equation with the supply of money from the United States revealed the extent of intermediation services offered by the United States to the globe. The home demand for money in the United States necessarily was less than the supply of money furnished by the United States. As Laffer put it: “For the United States, the financial intermediary nation, the increase in domestically held money does not come solely from balance-of-payments surpluses,” as is the case for all other countries in this model. “Being the intermediary nation, the United States is the world’s producer of money and, therefore, the increase in domestically held money equals the amount of domestically produced money less the overall payments deficit.” As he worked out the equations with these observations in mind, Laffer found that he had “most of the essence of the IFI hypothesis.” His equations showed that changes to interest rates would do little to stem the general flow of capital into or out of the United States. Global demand for money from the sole supplier minus the home demand from that supplier was determinative. As for the current account, correlating to the trade balance, Laffer found that it “does not enter into the determination of the overall balance of payments. In fact, any increase or decrease in the current-account surplus of the United States will be matched pari passu by an increase or decrease in the deficit on capital account.” He identified the heart of the matter: “Furthermore, the only factors that will affect the overall balance of payments of the United States are the absolute increase in the supply of money in the United States, the relative rate of income growth between the United States and Europe” (or the world), “and, finally, the diminutive effect … of changes in the price term for money,” which Laffer dismissed as minor. The increase in the American supply of money and the difference between the supplier of money’s growth with that of the rest of the world—these were the exclusive determinants of the composition of the balance of payments. There was no residual that had to make up for native inefficiencies in the international monetary system. When he arrived at Brookings, Laffer befriended Salant’s colleague Edward F. Denison, who had just published, to considerable discussion, a book on Why Growth Rates Differ (1967). Denison’s chief concern was to determine why, since 1950, Western European growth rates were higher than the American growth rate. His conclusion was that Western Europe was playing catch-up. It was making productive shifts from agriculture to industry and integrating its internal market as United States had years before. Growth rates, along the Denison model, would probably soon



converge, but for a residual institutional factor (mainly education) whose import was unclear. The topic of the growth differential between Western Europe—the slow-growth United Kingdom typically excepted—and the United States had been a major item in political-economic discussion since the 1950s. Fashionable left-wing opinion had it that the Soviet growth rate was superior to that of the United States. A graph in Paul Samuelson’s Economics textbook extrapolated current reported trends such that the economy of the Soviet Union would be larger than that of the United States in several decades’ time.12 Laffer’s year at Brookings reflected the incorporation of just this theme—differential rates of growth—as the means of expanding and generalizing the model suggested in the AER “Comment” of June 1967. In that piece, Laffer had defended the currency regime from a specific charge. He found that “speculation” was not a necessary term in accounting for short-term capital flows. In the economics he developed over the next year, he strove to outline a comprehensive and positive model that accounted for all monetary flows under the aegis of the given international monetary system. The key he would discover was differential rates of growth. These determined the central characteristics of international monetary movements and overwhelmed all residuals to rounding errors. In his remarks from the 1970 conference, Salant observed that Laffer’s paper offered “another theory of enduring deficits,” or “equilibrium deficits,” as he also put it. Salant’s own financial intermediation thesis had been a primary entry in this body of theory. Salant pointed as well to work in this vein that dated from before his “classic” co-authored 1966 Economist article, including by Edward Shaw and Tibor Scitovsky, who would be two signatories of Laffer’s 1971 dissertation. Salant concluded his remarks with an extended discussion of “a promising extension and test of ideas … concerning the effects of growth on the balance of payments” that had recently come in an unpublished paper of Laffer’s. This was “An Anti-Traditional Theory of the Balance of Payments,” dating from 1968, which elaborated in full the model Laffer would call on in his conference paper and indicated the extent of his research at Brookings during his year on leave.13



“An Anti-Traditional Theory” When Laffer weighed the Chicago offer in the spring of 1967, a major part of the pull of that institution for him was the chance to be a colleague of Mundell’s. Laffer recalls having become acquainted, as a graduate student, with Mundell’s work, but what really hooked him was the mimeograph paper of Mundell’s that McKinnon had recently given him. This was “Growth and the Balance of Payments.” Mundell had presented it at a conference he had organized at the university in September, in his first act as a tenured (and full) professor. He published this paper in 1968 in his collection International Economics. The brief (six-page) paper made quick work of the conventional wisdom. “A dominant theme of post-World War II writing on international adjustment theory is that the balance of payments is a restraining factor upon economic growth,” he wrote to begin. Because growth typically results in an excess demand for imports over the slower-growing world’s demand to receive and absorb the growing country’s exports, “countries that are growing rapidly relative to the rest of the world will eventually have to impose increasing trade restrictions” or other remediations. “Alternatively”—and here lurked the argument that economic growth could not abide fixed exchange rates—“their currencies must undergo progressive devaluation.” Mundell lit into this view: “No theory advanced in the postwar era has been more greatly in conflict with the facts. One could point to the experience of ‘surplus’ countries,” naming Germany and several other Continental countries along with Peru, “as examples of countries with convertible currencies that have grown rapidly, and to the experience of ‘deficit’ countries,” naming the United States, Great Britain, and Belgium, “as examples of countries that have grown relatively slowly. However, this appeal to facts is quite unnecessary, because the theory itself is inadequate and misleading. High growth rates per se might just as well be said to induce balance-of-payments surpluses, not deficits.” The paper then went on to a characteristic Mundell graph. It plotted two schedules against each other. One was for the propensity of the inhabitants of a country to hold money at given levels of wealth and interest and the other for the propensity to hold investments in the same context. The graph showed that as growth occurred, and a portion of the growth was retained as savings, resulting in an increase in wealth, there was domestic demand for new money as a savings instrument. However, “because



international reserves are not produced at home, the community must acquire them from abroad by running an export surplus. The fact of growth therefore implies a balance-of-payments surplus. Net exports … will be exchanged for … international money. The decision to save per se implies a decision to acquire additional money balances.” And acknowledging the current fixed-exchange-rate system, “when money balances are equivalent to international reserves this implies a balance-of-payments surplus.” Mundell suggested that the root of the problem in the conventional view lay in not giving due regard for one of the main consequences of growth. “Given the saving decision [that occurs with growth] the community makes a portfolio decision at the margin.” The portfolio decision, to save a greater share of marginal income, requires under fixed exchange rates an increase in money flows at par from abroad. “One way of interpreting the mistake in the traditional analysis is that it makes the demand for international goods depend on income rather than domestic expenditure and thus misses the connection between the demand for international goods (and, more generally, all consumption) and liquidity requirements.” When a country grows, it will increase its marginal savings with respect to consumption. If the “traditional analysis” would take into account marginal domestic expenditure (and thus its inverse, marginal saving) when considering income growth, it would ward off the improper conclusion that “the balance of payments is a restraining factor upon economic growth.”14 Mundell probably owed his thinking on portfolio decisions that came with increases in wealth to the portfolio theory of James Tobin, whom Mundell credited in various contexts when writing about such issues. He would refine his views on the matter while a colleague of Laffer’s at Chicago. Mundell’s 1971 book Monetary Theory included various reflections on this score. In an essay in that book on “Monetary Theory and the World Gold Standard,” Mundell revisited themes similar to those of “Growth and the Balance of Payments.” The graphs in each piece had similar axes and schedules. The one in the gold piece measured the propensity to hold gold and non-gold assets against rates of interest and was capable of illuminating the consequences for gold-holding under the conditions of growth. Generally, Mundell’s point was that given growth, while the absolute demand for gold goes up, the respective marginal preference for holding gold goes down.15



Laffer’s “Anti-Traditional Theory of the Balance of Payments,” which Salant had in typescript in 1968, and which exists now in archival copies dating from late 1968 and early 1969, credited six sources in the literature. These were Mundell’s “Growth and the Balance of Payments,” the Despres et al. Economist article, Denison’s Why Growth Rates Differ, and work by McKinnon, the AER editor George Borts who would consider the paper for the journal, and Jeffrey G. Williamson on the history of the American balance of payments in the century prior to 1913. “The purpose of the paper,” as it put forth at the outset, was to reach past the suggestiveness of the Mundell work in particular and “to develop a general equilibrium model of the balance of payments and to derive the relationship between growth and the balance of payments.” Laffer has held, throughout his long career, that among all the work he ever produced (along with the tax ellipse embedding the Laffer curve as he elaborated it in the 1980s), his “Anti-Traditional” paper developed his economics to the greatest extent. Like Mundell’s, and if in less affronted prose, Laffer’s paper began with a summary of the conventional wisdom it wished to repudiate. “An implication of the traditional balance-of-payments theory is that a retardation of real economic growth will lead to an improvement in the overall balance of payments. If income does not increase, so the theory goes, neither will imports. Exports, however, which are the imports of other countries, will increase with … the incomes of other countries. Thus, if the rate of growth of income is retarded, the trade deficit (surplus) of that country will be reduced (raised).” Laffer had set in his sights the same issue as Mundell, but he was framing it from the opposite perspective, that not of economic growth but contraction in a country. “Net private capital flows,” the introductory paragraph continued, “which are assumed to be basically independent of the net goods movements, will not be changed materially and government capital flows or gold movements will be improved. Thus a retardation of growth will lead to an improvement in the overall balance of payments.” Such was the premise to be challenged. In the empirical portion of the paper at the end, Laffer supplied a definition of “the overall balance of payments of a country,” which “is taken to be the change in international liquidity (gold, reserve positions in the Fund [the IMF], and foreign exchange) from the beginning of the time period to the end of the time period.” The balance of payments was used in the colloquial sense, not netting by necessity to zero but excluding the final clearing via the



mechanisms of the monetary system. In the late 1968 and 1969 versions of the paper, the full title specifies the monetary regime: “An Anti-­ Traditional Theory of the Balance of Payments Under Fixed Exchange Rates.”16 The main arithmetic innovation of the paper was to derive an import function for each country as a residual of other functions, including exports and the increase in income and expenditures, as opposed to identifying import functions for each country and then summing them. “With an independent import function … and an independent export function for each country, it would be mere coincidence, if, in fact, total ex ante exports did equal total ex ante imports.” Given that total world imports must equal total world exports, using sums of individual functions in every case courted distortions. Laffer suggested that such problems were systemic in the “traditional approach.” As he wrote, “traditional balance-of-­ payments theory is principally an adjunct to domestic macro economic analysis.” This point echoed “Growth and the Balance of Payments,” in which Mundell had cautioned against using disaggregated national income of a country as the determinant of the import function. Rather, a residual of national income, the expenditure function, should determine the import function. If in constructing the major variables shaping the balance of payments, the “traditional analysis”—the term Mundell used in his paper— improperly estimates the propensity to import, the chance, as Laffer explained in his, that summed national import functions achieve the necessity of world imports equaling exports is vanishingly small, and even in that case a matter of coincidence. Mundell chided the “traditional” approach for failing to analyze domestic propensities correctly, while Laffer reframed domestic marginal propensities as functions of global trends. In the model Laffer was about to sketch, as he wrote in the opening section of his paper, he assumed small countries that were international price-takers for both imports and exports. This would have decisive consequences in his model. If growth happens in a small, integrated, price-­ taking country, it means that the country is expanding its production. Specialization requires that small, integrated countries proportionately produce exports as they spend more generally. In growing, a country sees an increase in its trade deficit, in that growth raises the rate of investment return and calls forth foreign capital. At the margin during such a process, inhabitants in the growing country increasingly hold money balances, as



Mundell had been at pains to point out. The small country imports all money. Therefore, the increase in the trade deficit is less than the increase in the capital balance of the country on account of first, the flows associated with the rise in the country’s rate of investment return; and second, the inhabitants’ acting increasingly in the role of people who are holding more money balances. Laffer began the main section of his paper with a Cambridge cash-­ balance equation, Ld=kY, where k is the income coefficient of the demand for money and assumed to be a constant. Ld and Y are, respectively, the demand for money and the “income/output” of a country. Laffer assumed the price level to be constant on the grounds that in the country being a price-taker in all transactions, there was one world price level. In the latter section of “Growth and the Balance of Payments,” Mundell had used the Cambridge equation to show how substituting domestic expenditures E for income Y would prove his point. Laffer proceeded to derive an export function for a country that was relatively growing against the world. He assumed that at the margin, the propensity to export could change, and probably weaken, in this context, given that greater production might entail a change in the composition of production. He took Mundell’s expenditure function, and combining this with his own export function derived an implicit import function. As he pointed out, this function differed little from either Mundell’s or McKinnon’s. Next Laffer considered capital flows into the country, considering them “definitionally equal” to the change in money demanded by a country over period of time minus the difference between its expenditures and income. Substituting terms, he found that the balance of payments was equal to the income coefficient (k) times the change in output. “Under the assumptions of the model described,” as he wrote, “the balance of payments of an economy is positively influenced by the absolute growth of that economy.” The crucial matter, as he put it, was that “the capital account is more sensitive to income growth than is the current account.” This had been Mundell’s point. At the margin, growing countries increasingly prefer saving to consuming. This results in an increasing preference for foreign money, for capital inflows, over foreign goods, over imports. Given fixed exchange rates, growth in one country requires that money flow into it. Laffer had built on Mundell’s paper by, first, offering a comprehensive complement of derived equations, and specifying a small-country and



then a full model, in the place of Mundell’s sketch of the basic idea. He also dispensed with Mundell’s assumption of capital immobility, which Mundell seems to have used so as to lay stress on how strong the demand for money as opposed to capital could be in a growing country trading with the world. Laffer assumed the free movement of capital and goods. Finally, Laffer stressed the point that the key matter was a country’s relative growth. The more a country exceeded world growth, depending on its size and therefore the proportion of its exports and imports to national output, its balance-of-payments position would improve. In the final section of the paper, Laffer called on data from major countries in the 1950s and 1960s and found it consistent with his equations. His chief calculation concerned the ratio of changes in a country’s balance of payments with relative changes in their growth rates. He found the statistical differences to those derived from his model to be small. He quoted a passage from Jeffrey G. Williamson’s now classic 1963 book, American Growth and the Balance of Payments, 1820–1913, an extended narrative presentation of the counter-cultural view in its premier case, the United States as it became the world’s largest economy in the nineteenth century. “Alterations in the trade balance were actually overfinanced by similar, more striking fluctuations in net capital imports” into the United States in those years, as Laffer quoted Williamson. Laffer’s paper was an endeavor to elaborate in full a theory of global stability under fixed exchange rates that had gained in adherents in recent years despite a raging discourse asserting systemic crisis.

The Platform of Supply-Side Economics Students of Laffer’s career may expect that in its early stage of rapid development and ascent, some first traces of the Laffer curve can be found. At a minimum, tax rates must have been a notable point of consideration, as this economist who was incorrigibly tax-minded during the 1970s trained in and then joined the profession at a high level in the decade before. The sources will not meet such expectations. Laffer’s work, from these early years, at most tangentially referred to taxation, perhaps only in an occasional mention of tariffs. Mundell’s work, in contrast, dealt with taxation to a considerable degree. Mundell treated the economics of tariffs regularly. His Nobel-inspiring papers on the fiscal-monetary policy mix from 1961–64 explicitly considered aggregate tax changes. And in testimony to



Congress in 1966, he said that according to his model the United States should have increased taxes the year before.17 Through 1968, inclusive of the end of his graduate training, his joining the profession via a tenure-track appointment, and his occupying a post at the premier Washington policy think-tank, Laffer was a student of one subject in economics. This was the status quo of the international monetary regime. Laffer was a defender of that status quo. His research interest focused on picking off criticisms of that status quo which he, rather correctly, saw coming from all directions. He started small. Jerome Stein saw perturbations in short-term capital movements as speculative bets that the fixed-exchange rate system was wobbly. Laffer responded by wiping out the speculation motive with the explanatory variable of trade finance. In his work at Brookings, in particular the “Anti-Traditional” paper, he went after larger game. Like Mundell, he took on one of the central arguments regarding the instability of the Bretton Woods system, that it could not abide growth. He worked out a model that made a claim to be greater than Mundell’s, in that it endeavored to be fully elaborated. It may be asked: where was taxation? It was not there, explicitly. What was emerging as a major unaddressed issue, however, was apparent in the “Anti-Traditional” paper. Moving toward the center of Laffer’s economics was domestic growth. Domestic growth was becoming the uncaused cause in both his and Mundell’s economics, the central determinant of international equilibrium under fixed rates. Necessarily, these economists had to take the next step, to address the matter of what was this force that occasioned growth in country that so supported and justified the current balance-­ of-payments system. In the “Anti-Traditional” paper, Laffer almost hit upon the issue squarely. At the end of the paper as he mused about the results: “Let us imagine a $50,000 million economy (approximately Italy’s size in 1965). If we could raise its growth rate by one percentage point above what it would have been, what could we expect to occur in the balance of payments?” A footnote added, “the sources of the additional growth are unimportant for our purposes,” and suggested consulting Denison’s new book from Brookings on Why Growth Rates Differ. The causes of domestic growth had recently been a hot topic in economics. The growth theory elaborated by Robert Solow in the late 1950s, concerning a “residual” that came from such factors as technological change and institutional improvements, was the ascendant model. President Kennedy had made increasing the American growth rate, perhaps doubling it to 5 percent, an issue in his 1960 campaign and a goal of



his administration. “Growthmanship” was a somewhat derisive term in public discourse used to refer to the excessive regard certain officials, such as the economists at the Council of Economic Advisors, had for policies that might encourage further economic growth.18 As for what policies might achieve economic growth, Kennedy ultimately chose tax-rate cuts and tax simplification as the centerpiece of his economic policy—the tax cut of February 1964, which had passed the House of Representatives in September 1963 and was under consideration in Senate committee at the time of the assassination in November. Generally in academia and public policy, other means than tax-rate cuts were preferred. These included institutional improvements, including in education and infrastructure, and indeed devaluing the currency so as to spur exports. Laffer and Mundell naturally balked at any suggestion of devaluation, and they had begun occasionally to use in this context that unhoneyed entry in economics jargon, “endogenous.” There was some secret to domestic growth that would have to be explored if their international currency economics was to progress beyond its current form. In his testimony to Congress in 1959, Triffin had noted that the main contribution to the American balance-of-payments deficit, necessitating the big gold outflows, was on the capital account. American exports of capital, along with government foreign aid, dwarfed the trade deficit, which itself was new in 1959 after years of surplus. According to the economics Laffer and Mundell were developing, there was an easy solution to this problem. Domestic growth relative to the world, particularly in the “Anti-Traditional” model, occasioned substantial capital inflows and would resolve the problem Triffin had identified. For his part, Mundell had written extensively on the problem of foreign aid. His 1960 AER article treating “The Transfer Problem” worked out how intergovernmental transfers distorted the terms of trade and knocked the payments system off of balance. That long article also entertained the problem of a small country specialized in production that alone experienced an increase in productivity—that grew. Calling on the language of John Stuart Mill, Mundell conceded that in that case, growth might be “damnifying,” in that the country might try to “push” exports onto a recalcitrant world market. Laffer dismissed that case in the “Anti-Traditional” paper, and furthermore offered that a big non-specialized country that grew of its own accord would present quite a different example, of a country occasioning massive global monetary creation to absorb the highly beneficial effects of a people getting rich.19



Notes 1. Jude Wanniski, “The Mundell-Laffer Hypothesis—a New View of the World Economy,” Public Interest 39 (Spring 1975), 31–52; The Way the World Works, x. 2. Nobel Prize “Press Release,” Oct. 13, 1999, 3. R.A. Mundell, “Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates,” Canadian Journal of Economics and Political Science 29, no. 4 (Nov. 1963), 475; Rudiger Dornbusch, “Robert A. Mundell’s Nobel Memorial Prize,” Scandinavian Journal of Economics 102, no. 2 (June 2000), 202. 4. Dornbusch, “Robert A. Mundell’s Nobel Memorial Prize,” 208; Mundell, “The Collapse of the Gold Exchange Standard,” American Journal of Agricultural Economics 50, no. 5 (Dec. 1968), 1123; Dornbusch, “The Chicago School in the 1960s,” Policy Options, May 1, 2001; Russell S.  Boyer and Warren Young, “Mundell’s International Economics: Adaptations and Debates,” IMF Staff Papers 52 (Special Issue, 2005), 165, 169. 5. University of Chicago Record 1, no. 2 (Dec. 21, 1967), 12. 6. Emile Despres, Charles P. Kindleberger, and Walter S. Salant, “The Dollar and World Liquidity—A minority view,” The Economist, Feb. 5, 1966, pp. 526–29. The quotations from this article in the following paragraphs, including the response from the editors, are from this source. 7. Judy Shelton in “Money without Coherence,” Cato Daily Podcast, Cato Institute, Washington, DC, August 7, 2015. 8. Robert A.  Mundell, International Economics (New York: Macmillan, 1968), 3. 9. Robert Triffin, “The International Monetary Position of the United States,” Hearings before the Joint Economic Committee, Oct. 28, 1959, p. 2906. 10. The proceedings are Fritz Machlup, Walter S. Salant, and Lorie Tarshis, eds., International Mobility and Movement of Capital (New York: NBER, 1972). 11. Arthur B. Laffer, “International Financial Intermediation: Interpretation and Empirical Analysis,” in Machlup et al., eds., International Mobility and Movement of Capital, 661–684. The quotations from this chapter in the following paragraphs are from this source. 12. Paul A.  Samuelson, Economics, 9th ed. (New York: McGraw-Hill, 1973), 883. 13. Walter S. Salant, “Financial Intermediation as an Explanation of Enduring ‘Deficits’ in the Balance of Payments,” in International Mobility and Movement of Capital, 616, 652.



14. Mundell, International Economics, 134–39. 15. Robert A. Mundell, Monetary Theory: Inflation, Interest, and Growth in the World Economy (Pacific Palisades, Calif.: Goodyear, 1971), 80. 16. Laffer, “An Anti-Traditional Theory of the Balance of Payments Under Fixed Exchange Rates.” Quotations in the following pages come from this source. 17. Robert A. Mundell, “Prepared Statement,” New Approach to United States International Economic Policy: Hearing before the Subcommittee on International Exchange and Payments of the Joint Economic Committee, Sept. 9, 1966, p. 6. 18. Robert M.  Collins, More: The Politics of Economic Growth in Postwar America (New York: Oxford University Press, 2000), 17. 19. Mundell, International Economics, 26.


Rising at Chicago

While at Brookings in early 1968, Laffer composed a short piece for the AER which appeared in the journal in September, as he took up residence in his position as an assistant professor on the faculty of the University of Chicago School of Business. This was a book review of the recently released Economics of Cycles and Growth by Stanley Bober of Duquesne University. All of a page in length, it is the earliest written indication we have of the initial outline of what would become, in the 1970s, Laffer’s vision of supply-side economics.1 The review is written from a superior perspective. “If one feels that there is a need in the economics curriculum for a specific course in business cycles this text is quite well suited to the task. Mr. Bober has diligently gone through the literature … and has to a large extent synthesized the essence,” the review began. The book was “fairly well-balanced,” the “tools and techniques” were “developed and explained prior to being used,” and “adequate coverage is given to the data.” The book was a workmanlike effort; it had areas of competence. “Most of the historically important models of the business cycle … are explained thoroughly and concisely.” Then came “however, there are some major shortcomings.” Laffer spent the next two paragraphs on what he saw as the book’s omissions, using them an opportunity to sketch his own developing notions about what mattered in economics and economic policy. Laffer made three points. The first was that “at no time was I able to find any © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 B. Domitrovic, The Emergence of Arthur Laffer, Archival Insights into the Evolution of Economics,




mention whatsoever of money … or monetary policy. This omission, however, was typical of the business cycle literature of the late ‘thirties, ‘forties, and early ‘fifties. Monetary explanations or even partial explanations were completely out of vogue during that period.” Laffer’s readership would have recognized in this criticism, surely, a reference to Milton Friedman’s recent efforts at touching off a revolution in thinking about the importance of monetary affairs. Friedman and Anna J. Schwartz’s Monetary History of the United States had come out in 1963, and its companion The Great Contraction, 1929–1933 two years later. These works would prove immensely influential in calling into being a consensus that adverse macroeconomic variations, the Great Depression in particular, owed themselves to the mistakes of the Federal Reserve System. Early twenty-first-century Federal Reserve Board Chair Ben Bernanke was a high representative of this consensus. As Bernanke said somewhat notoriously as a Fed Board Member in a keynote lecture for a conference in Friedman’s honor in 2002, “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”2 Laffer would not get to know Friedman—and become lifelong friends (and intellectual sparring partners) with him—until after he arrived at Chicago that fall in 1968. Yet at the time of this arrival, as the AER review indicates, Laffer wanted the profession to take up the challenge of Friedman’s monetary interpretations. To date, Laffer had not produced work in the Friedmanite vein. His work had a central monetary element, to be sure, but one characterized by largely private money flows under fixed-exchange rates. Friedman’s monetary economics stressed quite the opposite, Federal Reserve policy and flexible rates. But whatever the perspective, according to this review, Laffer felt that monetary maters had to be at the center of sophisticated macroeconomic analysis in the late 1960s. Second, Laffer faulted Bober because, in his book, “there is no mention of portfolio balance models or even how portfolio balance considerations would modify—if at all—some of the models discussed at length.” In this case, Laffer revealed an area of research in which he was currently highly active. His defense of the fixed-exchange-rate system, and that of his adviser Despres through his financial-intermediation thesis, turned on the point. Accumulations of short-term capital abroad, as in Laffer’s 1967 AER “Comment,” and of dollars in foreign reserve accounts, as in the



Despres-Salant-Kindleberger work, corresponded to global portfolio preferences within the prevailing monetary regime whose major characteristics were fixed exchange rates and the dollar linked to gold as the top key currency. Indeed, to these economists, and in addition Mundell, the distended contemporary discussion about the dollar glut and the American balance-of-payments “deficit” derived from the failure to see the importance of portfolio preferences in a system such as that of Bretton Woods. Laffer found no mention of the issue in Bober’s book. In keeping with his own priorities, he declared it an omission. Third, Laffer delved into a matter he had not taken up to date in his own work. “The other very important omission, which appears to have been deliberate [preface vii], is any discussion of monetary and fiscal policies and attempts to stabilize business fluctuations,” as he wrote. The reference to the preface appears to have been a comment on Bober’s part that a treatment of stabilization policy would be a distraction, taking away attention from the natural forces of the business cycle and impeding analysis of those cycles. Laffer continued, “with the ever-increasing importance of the government sector and the apparent realization in the post-­ Eisenhower era of the potential stabilizing effects of government receipts and expenditures, this is a major omission, indeed. Not only are stabilization measures important from a policy point of view, but discussion of them is an excellent teaching device.” This was a new Laffer, one more recognizable from the later perspectives of the 1970s and 1980s. Laffer went on: “As many recent articles show, different forms of lags and leads have very different effects on national income, employment and prices over time. An understanding of the underlying mechanism of the business cycle is not sufficient; one must also have some understanding of the tools at hand.” In the 1950s and early 1960s, “built-in-stabilizers,” as they were commonly called, of regular governmental economic interventions aimed at smoothing out the business cycle were central topics of consideration in economic policy. Built-in stabilizers included, on the fiscal side, the progressive tax code and unemployment insurance. Discretionary ones on the monetary side included counter-cyclical Federal Reserve policy. Average tax rates that went up and down with aggregate income were to blunt economic expansions and reduce the severity of recessions, the theory went, as would paying into and then receiving unemployment benefits. Federal Reserve Chair William McChesney Martin would “take away the punch bowl” and raise rates during an expansion before it got too heady



and then loosen with downturns. The economic-stabilizing potency of the government was a cliché as an issue as of 1960, when Kennedy made clear in his campaign that he called for new ideas in economic policy beyond the automatic, “do-nothing” preferences of the Eisenhower-era government. It certainly was a cliché by 1962, when at Yale Kennedy appealed for a new approach to fiscal and monetary policy and sneered, in this specific context, at “incantations from the forgotten past.”3 James Tobin’s New Economics sought to devise ever-different “policy mixes” for the Kennedy administration, blending distinct monetary, tax, and expenditure policies for each situation so as to find an optimum of growth with minimal cyclical variations. In this the New Economics had seen itself as the economic policy-intellectual vanguard of the early 1960s. Surely in his AER review, Laffer did not wish to advocate this well-worn (by 1968) establishmentarian economic-policy posture. More likely he had been reading Mundell.4 Laffer recalls that it was McKinnon who had introduced him to Mundell’s work—who had given him an “offprint” (Laffer remembers this word he had not heard before) probably in the fall of 1966 of “Growth and the Balance of Payments.” If Laffer had not read Mundell to that point (he had passed the last of his doctoral exams the previous spring), he should have. Mundell was the big new thing in economics at that time. His record of output in the journals following his MIT Ph.D. of 1956 was stellar. By the time he turned twenty-eight in 1960 (Laffer’s age as of his arrival in Chicago in August 1968), Mundell had two full articles plus a review in the AER, an article in the Quarterly Journal of Economics (QJE) and an article in the Canadian Journal. From the fall of 1960 through 1965, he added another article and two reviews in the AER, two articles in both the Canadian Journal and the IMF Staff Papers, an article each in Econometrica and Kyklos, and fully four articles in the Journal of Political Economy (JPE), among other publications. Three full articles in the AER, four in the JPE, another in the QJE and Econometrica, and so on, in the nine years after his degree—this was preternatural output. Oddly, Mundell does not appear to have had a tenure-track job in these years. He bounced from temporary positions at Stanford, the Johns Hopkins center in Italy, the IMF, McGill University, and Brookings. He was a visiting professor at Chicago in 1965–1966, probably testing the place after he had received a tenure offer. When he became a full professor of economics at Chicago in 1966, it may have been the first time he was on the tenure-track, in this case at the terminal point. It also marked the



end of his period of original research. His publications from that point on, after he gave the “Growth and the Balance of Payments” paper as his very first act as a tenured (and full) professor in September 1966, would largely be confined to recapitulations of what he had done in 1956–1966. Somehow, tenure—and Chicago—killed off his productivity. If Laffer had been delving into Mundell’s vast recent contributions in the journals after McKinnon gave him the paper, he would have encountered several major entries along the lines of “The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability,” as in Mundell’s 1962 IMF Staff Papers piece which he reworked for the Canadian Journal in the article that would help gain him the Nobel Prize. This IMF article itself was a further rendition of his 1960 QJE and 1961 Kyklos articles on policy and stabilization. As Mundell recalled the sequence of events, in 1961 his supervisor at the IMF Jacques Polak had urged his staffer to rewrite his thoughts on stabilization for the Fund, because “not enough people have got the message.” In the article that came out, Mundell anticipated Kennedy at Yale. A “high” (as Kennedy said) or perhaps “tight” or at least “not-loose” (to use more conventional language) monetary policy would guarantee the dollar, while “flexible” fiscal policy implying “deficits” (both Kennedy’s terms at Yale) via tax cuts or spending increases would guarantee domestic productivity and employment. It is possible that Mundell’s ideas in the IMF piece came to Kennedy shortly before the Yale address. In May 1962, secretary of the treasury C. Douglas Dillon heavily underlined a Bank of International Settlements report that Mundell had probably influenced, in a briefing to Kennedy.5 If Laffer after 1966 was caught up in Mundell’s work, and in 1968 was accusing economists of neglecting stabilization policy when they wrote about the business cycle, he had, surely, been reading in Mundell’s work on the international-domestic economic policy mix. Stanley Bober’s book got rough treatment from Laffer, to be sure, but in the manner of a non sequitur. The review was not so much that as a vehicle for Laffer to state the subjects of further inquiry which he felt the field, and in particular he himself, should be exploring as a matter of urgency. The review was a statement of what Laffer felt he believed, and what he should delve into as a scholarly researcher if not policy advocate, as he joined a legendary university economics faculty while the monetary system he adored was going through what turned out to be death throes. The review indicated, furthermore, that without mentioning Mundell’s name Laffer could barely contain his enthusiasm about joining Mundell in



Chicago, which he did as the review was published in the AER in September 1968. As this piece all but showed, beginning immediately Laffer would be pursuing ideas at which he and Mundell had jointly arrived. These concerned the stability of the fixed-exchange rate system; he would be furthering his consideration and advancement of Mundell’s ideas about portfolio preferences as an explanation of phantom American balance-of-payments deficits; and he would be launching a new inquiry (for him) into stabilization policy. And it would all happen with Mundell proximate as a fellow faculty member. There was a tip-off to his interest in Friedman as well. This came both in the reference to the monetary factor in general and in the specific mention of “different forms of lags and leads.” This was language which Friedman had brought to the fore in his discussions of the temporal effects of changes in monetary policy. To end the brief review, Laffer wrote, “in spite of the title of this book, the surface of the subject matter of economic growth is barely scratched.” Laffer might have said this about himself. Economic growth domestically achieved was becoming the central matter in his justifications of a classical-­ like international monetary system, and he had yet to address it directly.

Not “An Anti-Traditional” But “A Monetary” As Laffer moved to Chicago and took up his faculty position at the Graduate School of Business, his first scholarly priority was to circulate the “Anti-Traditional” paper and submit it for publication. He showed it to Professor Harry Johnson, who with Mundell ran the international economics or “trade” workshop and had Laffer present it in that forum. The workshops—their proper name—of the Chicago economics faculties had begun in the 1950s under the direction of (social science) department chair Theodore Schultz, who had pioneered the concept in 1947 with a prototype in agricultural economics. Workshops were forums for the presentation of works-in-progress, mainly that of faculty but including, occasionally, that of advanced graduate students and visitors as well. Graduate students participated in the workshops for credit. In the 1960s, there were about ten workshops, including others in Latin American economic development, urban economics, and industrial organization. The homey term “workshop” perhaps does not convey the seriousness of this institution within the Chicago economics faculties and, indeed, the University of Chicago as a whole. In the first place, the workshops were well-funded. The Ford and Rockefeller Foundations, among other sources,



provided grants to sustain the workshops that ran into the hundreds of thousands of dollars. Second, graduate students took them as classes. And third, the workshops facilitated the rise of what came to be known as the Chicago “school” (or schools) of non-Keynesian economics. The university administration came to be so impressed with the stature of the Chicago economics faculties that it instituted workshops across the disciplines in the 1980s. Economists at Chicago did not as a rule work alone, the cloistered scholar of lore, and come out with a publication that few had seen in preparation. Rather, as a matter of course, faculty submitted their work-in-­ progress to the rigors of the workshops, which met upwards of weekly. This arrangement served if not to enforce a Chicago economics orthodoxy, then to ensure that much of the published work that came from Chicago faculty members (and graduate students) had similarities of style and methodological perspective, such as might be suggestive of a school-­ of-­thought. Historian of economics Ross B. Emmett has interpreted the workshops as essential to the rise to prominence and influence of Chicago economics. For Emmett, the workshops “created an integrated framework for research and teaching that enabled the expansion of the Chicago approach to economic science across the disciplinary spectrum (and eventually beyond). To use Kuhnian language”—that of Thomas S. Kuhn in The Structure of Scientific Revolutions (1962)—“the workshop system provided the means for the normalization of the Chicago paradigm.”6 Whether there was a unitary or otherwise identifiable Chicago paradigm is another question. The workshops had aspects of diversity. Of Friedman’s money and banking workshop, J. Allan Hynes, a graduate student at Chicago in the early 1960s, recalled that, “Friedman ran a tight ship. Papers had to be circulated a week in advance and it was assumed they had been read. The papers were not presented but discussed. This to a large extent involved Friedman’s going through the paper line-by-line, commenting both on the quality of the economics and the writing— apparently neither were as a rule very satisfactory.” According to Rudiger Dornbusch, however, “the international workshop of Mundell and Harry Johnson was quite the opposite; often there were no papers and even when there was something, Mundell’s tendency for going off course to his latest ideas easily penetrated; order was discouraged, speculation was at a premium. Harry Johnson would carve little animals from wood”— Johnson was a compulsive whittler—“and occasionally pronounce, Mundell was unstoppable and Socratic. He never, never in the time I saw



him in Chicago” (which was around the time Laffer would have presented the “Anti-Traditional” paper) “answered any question other than with another question. He always held that what was already on paper was too stale to look at or talk about, what was just in the making was the challenge. That was not easy for the paper presenter.” Dornbusch believed that future famed IMF economist Michael Mussa “came close to strangling” Mundell in his mind after being on the receiving end of one of these workshop performances of its co-leader.7 If Keynesianism was thoroughly out of vogue at Chicago, there still were fundamental disagreements. Laffer and Mundell were witnessing, as of 1968, the decomposition of the fixed-exchange-rate system they advocated in favor of a coming floating regime which Friedman touted. The title of Laffer’s piece, “An Anti-Traditional Theory of the Balance of Payments Under Fixed Exchange Rates,” was explicitly revisionist. It was anti-traditional. It was also, paradoxically, anti-reformist. It implied that the excellence of the current system was somehow remaining latent. If growth would only occur, the false aura of crisis that hung about the Bretton Woods system would dissipate. In Laffer’s (and Mundell’s) economics, it was as if there were natural racers among the nations of the global economy, but strains of economic conventional wisdom brought about policy—built-in stabilizers and taking away the punch bowl, for example—that pinioned them into going slow and being plodding. As a result, crises sprouted and festered while the otherwise strong country got blamed. As Kennedy had said at Yale, typical discussions “in politics as in economics” were “clogged” with “platitude.” The solution was to clear out the false wisdom and let the naturally engineered economic dynamos, above all the United States, the “deficit” nation without which there could be no crisis, run and in so doing erase the problem. Laffer probably got the usual Mundell treatment at the trade workshop when he presented the “Anti-Traditional” paper on some afternoon late in the first academic quarter of 1968. Mundell would have recognized in it his own inspiration (from “Growth and the Balance of Payments”) and could well have taken the opportunity to observe that what Laffer had “already on paper was too stale to look at or talk about.” Mundell had worked over Laffer with the “between” issue a year-and-a-half before. Unlike Mussa, Laffer only ever wanted to chuckle with and indulge Mundell. The warmth Laffer felt toward Mundell was essential to the



two’s both serving as the academic captains of the supply-side policy revolution of the 1970s and 1980s. Harry Johnson offered written comments on Laffer’s paper. They were brief but intriguing. Taking a page from Mundell, Johnson got stuck on the first page—the title page. The title of the paper to which Salant would refer in 1970 lacked the ending phrase “Under Fixed Exchange Rates.” Salant cited Laffer’s paper fully as “An Anti-Traditional Theory of the Balance of Payments.” The paper made no sense except for the condition of fixed exchange rates. Its central point was that money has to flow disproportionately into the capital account when one country has higher relative growth, so as to achieve balance under the equivalence of national currencies. Johnson was not concerned about the last words of the title but the first. He scrawled above them, “Why not call it ‘a Monetary Theory of - - -’ You can relate it back to Hume’s price-specie-flow-mechanism.”8 Laffer submitted his paper to the AER, which after review accepted it pending minor changes. AER Managing Editor George Borts told Laffer in the summer of 1969 to shorten it from 32 to 20 pages and “revise it in accordance with the referee’s recommendations,” after which “I shall be pleased to publish it.” Borts told Laffer that he expected that when Laffer sent the corrected paper back, it would be the final version ready for publication. In a move that would come back to haunt him, Laffer delayed on returning the paper to Borts. “An Anti-Traditional Theory” would never be published.9 As Laffer was prepping this paper for the international economics workshop and submission to the AER, he gave up on another publication. This was his dissertation. During his year at Brookings, president Kermit Gordon, with the support of economics head Joseph Pechman, proposed having the Institution’s press publish it as a book. The manuscript was on short-term, “hot money” capital movements and took up the theme Laffer had discussed in his 1967 AER “Comment.” An unfavorable external review came in from Peter Kenen, chair of the economics department at Columbia University. Kenen found inconsistencies between the claims Laffer was making in prose and his equations, disputed his seeing in certain bank balances evidence of trade finance, and in general was cool to the intermediation thesis the manuscript advanced. Salant told Laffer that “even though it has now been decided that Brookings will not publish it,” and despite a series of his own suggestions and criticisms, “I think you have a significant piece of work here and one that is well done.” For the moment, Laffer



dropped publishing this manuscript. In 1975, an updated version came out as a book.10 The manuscript that Brookings sent out for review in 1968, Laffer’s dissertation, had not yet been submitted to the Stanford authorities with an application for the Ph.D. degree. In his year at Brookings, Laffer seems not to have sent around the dissertation-approval form for his three readers, advisor Despres and committee members McKinnon and Shaw, to sign. Had he done this, and gotten the signatures, he then would have had to get final graduate-school approval of the dissertation plus submit a degree application to the university for the next commencement. These steps were those one had to take to get a Stanford Ph.D. given a finished dissertation. Laffer may well have been able to get the signatures in 1968. Despres was at Brookings with him. And Brookings’ sending out the manuscript for review for publication as a book suggests, rather strongly, that the Institution felt that the dissertation was finished. Perhaps Laffer (and Despres) overstated the certainty of getting McKinnon’s and Shaw’s signatures on request, or Laffer let the task of getting the signatures slide as he made his way in Washington that year. Among the scraps of evidence from that year on this matter is a remark Laffer made to McKinnon in a letter of July 1968: “I have not … forsaken the dissertation. … Walter Salant has been going through the dissertation with a fine tooth comb and I believe it is wise to wait and incorporate his suggestions—principally editorial.”11 Given the development of his own intellectual priorities, Laffer may have lost interest in the dissertation once the publication review came in negative in the summer of 1968. The dissertation represented a small, specific part of a more general theory he was busy elaborating. Its point that short-term capital flows were no witness to speculation against fixed exchange rates was a window into the larger interpretive framework of “An Anti-Traditional Theory.” That paper strove to speak of all financial (and goods) movements under the current international monetary regime. Moreover, it identified not a niche matter like short-term capital movements but economic growth itself as the prime mover of its model. As he settled into Chicago for the 1968–1969 academic year, Laffer dispensed with sending out the dissertation anew to publishers and instead got “An Anti-Traditional Theory” to the cusp of the AER. He had traded a Brookings press book on a subsidiary topic for an article in the field’s top journal that would outline his full counter-cultural model. As with the dissertation, however, the final fulfillment of “An Anti-Traditional Theory” required the last touches of housekeeping and follow-through. Laffer attended to them in neither case.



Publishing into the Crisis Over Laffer’s first year-and-a half as a Chicago faculty member, from the fall of 1967 through 1968, acute stress came to the international monetary system. In November 1967, British authorities devalued the pound against the dollar by 14 percent, making a mockery of the Bretton Woods standard of less than one-percent moves against par. At New Year’s 1968, President of the United States Lyndon Johnson appealed to Americans to restrict their travel abroad so as to prevent dollars coming into the hands of foreigners which then could be used to make a claim on the federal gold stock. Later that January, Johnson appealed to Congress to rescind the Federal Reserve’s “gold cover” requirement. This would place Federal Reserve gold at the disposal of the Treasury, which could use it against the redemption requests of foreign authorities.12 As Congress passed a bill to Johnson’s liking and sent it to the President in March, the international reaction came to a head. Several days before Johnson could sign the bill into law, the London Gold Pool broke down. This was a group the United States and several of its closest allies had set up earlier in the decade to fix the private price of gold. The United States, the United Kingdom, and the other select (and willing) members of the group provided a gold fund, a pool, that had one purpose. This was to sell into the market any time gold nudged above $35 per ounce. Whenever “speculators” of the variety of Jerome Stein’s in the AER, or more likely agents of Russian and South African gold producers, tried to bid up the private price of gold and thus poison the core of the Bretton Woods system, the Gold Pool would intervene to stop the process dead. In the second week of March 1968, it found itself overwhelmed and folded. The private price of gold on the London market went up and held over $40. It was a fine mess. Several days after the Gold Pool folded, Johnson signed the bill removing the Fed’s gold cover. Yet at this point, events had made the purpose of the law obsolete. There was nothing to do with the gold. The United States could not devote its newly enhanced fungible gold stock to redemption requests now that there was an unfavorable gap in the official and the market prices. A foreign authority could buy from the United States at $35 and sell privately over $40. After a flurry of shuttle and telephone diplomacy, it was agreed that countries would redeem dollars for official American gold on the understanding that they would not trade the gold on the market.



By the spring 1968, several essential elements of Bretton Woods were attenuated to the vanishing point. The British devaluation was inconsistent with exchange-rate fixity. And while the dollar was still redeemable in gold to foreign authorities, this gold was now sterile, not to be used otherwise as money. Furthermore, that arrangement was informal—there was no explicit sanction against breaking it. It made for an interesting lag in the journals. All manner of articles on the international monetary system were published during and shortly after the events of 1967–1968 that described conditions that no longer prevailed or were undergoing major changes. Laffer’s work was a case in point. In the first 1969 number of the aptly named Law and Contemporary Problems, Laffer spun out in some of his most eloquent prose to date the nub of his financial intermediation thesis. Law and Contemporary Problems was a (high-level) interdisciplinary journal that strove to communicate central issues of a social-scientific academic field in a non-technical fashion for a broad scholarly audience. In keeping with this spirit, Laffer’s “U.S. Balance of Payments—A Financial Center View” had no equations. Unlike his Brookings conference paper, the “Anti-Traditional Theory,” and nearly everything else he was writing professionally, it was all prose, getting its message across in words. In one crucial respect, however, Laffer’s article defied the spirit of the journal. The problem he was describing was no longer quite “contemporary.” It was quickly receding into the past. Laffer’s article endorsed, once again, the minority-view argument espoused by among others Despres that the world’s demand for the preeminent currency was necessarily strong. This was particularly so when as, at present, the volume of world trade, including trade not involving the United States, was growing. The dollar was such a preferred method for invoicing and transacting, globally, that the demand for it had to be high. Laffer noted that these realities meant that “it is conceivable that the United States will run out of gold, forcing the dollar price of gold to rise.”13 This conclusion was similar to that at which Despres and his co-authors had arrived three years before in The Economist, in which they reasoned that foreign governments would stop redemption requests when the American gold stock got low. Yet the thrust of the Laffer and Despres theory was that the big demand was for dollars per se—to enable trade and capital flows—and not for gold. Any new natural demand for gold would be small, however many dollars were in foreign hands. This demand



correlated not to foreign dollar stocks, but to the comparatively minor portfolio effects of global growth. With each extra increment of wealth, owners of assets would choose to hold in some small proportion more gold. That this understanding of the balance-of-payments issue was not garnering the respect of policymakers was clear to Laffer when he wrote this article. The sources it cited and the recent episodes it recounted suggest that it was completed sometime between January and March 1968 (prior to publication the following January). One of the myriad policy responses to the perceived payments crisis it took up was the American foreign-­ credit restraint program made effectively mandatory in January 1968. On the basis of the record of the voluntary programs that had preceded it, he judged the policy a failure. “Controls had virtually no effect of the balance of payments,” he found. Yet the very existence of the enhanced controls program, and the other increasingly numerous measures to restrict dollar outflow from the United States of 1968, showed that the financial intermediation argument was having little if any practical impact outside its proper realm of economics scholarship and discourse.14 As the developments in the monetary system unfolded, the journals adopted two-tiered approach in response to them. They continued to publish the heavily peer-reviewed and revised articles from their pipelines. These articles, necessarily, had been conceived and largely written sometime distinctly in the past. In addition, on the matter of the international monetary system, the journals increasingly published thought-pieces that were evidently prepared in some haste and as assessments of immediate developments. Examples from the Chicago faculty included Johnson’s “The 1968 Gold Rush in Retrospect and Prospect” in the 1969 Papers and Proceedings of the prior American Economic Association annual meeting as well as any number of articles by Mundell. The devolution of the Bretton Woods system was a professional boon to the fields of international and monetary economics. It enabled a raft of published commentary, and the solicitation of advice, from scholars working in the area. Mundell’s contributions were consistent with the Laffer-Despres line of argument, with a twist. Mundell noted that in the pound-sterling and Gold Pool crises of 1967–1968, France was acting deliberately, “trying to rock the boat.” France had made British devaluation a condition for French approval of Britain’s membership in the European Economic Community. As Mundell wrote in 1968, “France bears some share of the blame for the embarrassment of the British authorities in November. In the year leading up to devaluation, the world could witness the



unprecedented event of a major country calling openly for devaluation of the pound.” Mundell went on to say that France had seen what, effectively, Despres and the economists of his school had been alert to. This was that the dollar was becoming so important in global transactions, and as a preferred global store of value, that the role of gold with respect to the dollar was becoming ever more secondary.15 Here came the twist. Despres and the others, including Laffer, had asserted that the dollar’s usefulness of a global currency meant that there was no disequilibrium in the Bretton Woods system. Mundell conceded the credibility of this argument and took it one step further, to outside the realm of economics. The facts expressed by the financial intermediation thesis were becoming so manifestly clear that they compelled the French to try to break the momentum that was gathering in the direction of a reformulated system in which even gold would be subordinate to the dollar. As Mundell wrote, the French “anticipated what was going to happen, didn’t like what they saw, and attempted to change it.” The French undertook an effort “to resist the evolution to a dollar standard,” and had “to find an alternative.” He continued with this extraordinary passage: A common European currency was not yet in existence, so gold was the only contender, and so it was to gold that the French government had to turn. If the wings of the dollar were to be clipped, it was necessary to build up gold. That was the intention of M.  Giscard d’Estaing when he was Minister of Finance, and his policy was backed by de Gaulle and further implemented by d’Estaing’s successors. Now we could go on to develop a plot here. To weaken the dollar, it would at first be convenient to weaken sterling, for the dollar would be hurt by a substantial devaluation of sterling…. The French did achieve their aim of weakening sterling as a reserve currency. The next step was to weaken the dollar by strengthening gold…. When we look at events in this way, we arrive at a somewhat different interpretation of the sterling and gold crises. The formal breakdown of the system was not the important thing. It merely recognized fundamental changes that had already taken place. It was a palace insurrection. The revolution had already been won. The system would not collapse with the increase in the price of gold because it had already evolved into a new system over a year earlier.



Mundell called the overwhelming of the Gold Pool a “palace insurrection” undertaken by an inside participant. Over the years, he would refer to gold’s becoming, in the 1960s, a “passenger in the system”—a dollar-­ dominated system—and favorably quote Joan Robinson’s remark that Bretton Woods’ central institution, the IMF, was “an episode in the history of the dollar.”16 In Mundell’s understanding in the wake of the 1968 events, the dramatic actions that took place reflected efforts not to hasten the end of gold’s role in the monetary system, but to save and bolster it. This view ran wholly counter to the interpretations given by the numerous theorists of floating exchange rates that in the 1960s gold was becoming ever more irrelevant in the modern conduct of monetary and currency policy—that gold was if not a “barbarous relic” in Keynes’s famous phrase, it was an increasingly limiting and embarrassing anachronism. Mundell turned the tables on arguments of this stripe. He used the cogency of the financial intermediation thesis to conclude that any crisis the international monetary system may have been experiencing did not derive from the design, operation, and development of that system—but from political dissatisfaction with it. The notion that political as opposed to economic forces were pushing Bretton Woods into crisis was a current view in the mid-1960s. D’Estaing’s pronouncements about American “exorbitant privilege,” and French stockpiling of gold, a repetition of French behavior as the Great Depression gathered three-and-half decades earlier, made such an interpretation plausible. Despres, Salant, and Kindleberger had chafed, in The Economist, at that magazine’s using the term “the new nationalism” to describe American dollar policy, the credit controls for example. The authors thought that the term applied to others. American production of dollars was an international service, one they suggested that the European nations, France supremely, were too reluctant to acknowledge. “Europe Squeezes Itself” was a subheading in the Despres et  al. piece, which stated that “European authorities must be learning how much international trade in financial claims means to their economies” and have “discovered that liquidity in the form of large international reserves” is beside the point given the importance of the financial intermediation provided by the generous supply of dollars from the United States.17 Mundell was all but suggesting to his friends, beginning with Laffer, that no matter how compelling their arguments about the dollar system, the world did not happen to prefer that there was a dollar system. If



Europe was “squeezing itself” and “must be learning” and has “discovered” this and that about the veracity and beneficence of dollar intermediation, the signals were that the monetary system did not sufficiently comport with actual global political and policy attitudes and preferences. Mundell would develop these views in upcoming years, drawing a distinction between the monetary “order” and the monetary “system.” As the present author has summarized Mundell’s position on this score: “The monetary order is the kind of monetary system a society implicitly indicates it would like to have; the monetary system is whatever formal monetary arrangements there actually are (the Federal Reserve, floating rates, and so forth). The sum of mores, habits, aspirations, and common sense pertinent to monetary affairs in a society represents the monetary order; the system is the extant monetary apparatus. It is dangerous, Mundell believed, for the monetary system to stray too far from the underlying monetary order. Such things are liable to decouple a society from its political-­economic institutions—what political science calls a legitimation crisis.”18 In 1973, Mundell’s adviser Kindleberger would publish one of his most influential works, The World in Depression, 1929–39, his account of the forces that brought and kept the world into that terrible economic catastrophe. The book contended that the Depression crisis was one of leadership. World economic leadership had passed from Great Britain to the United States after World War I without anyone, the officials of these two powers in particular, much adjusting themselves to the new reality. The results were cataclysmic. While the given system was cursed with inherent instability, an effect of both the war and the peace agreement, there was scarcely any understanding on the part of the most powerful players of the productive roles that they could play. Kindleberger objected to the metaphor, offered by Bank of England official Ernest Harvey, that “‘Better a motorcar should be in charge of a poor driver than of two quite excellent drivers who are perpetually fighting to gain control of the vehicle.’ The analogy,” to Kindleberger, “of two excellent drivers fighting for control of the wheel may be more graphic than apposite. The instability seems rather to have come from the growing weakness of one driver and the lack of sufficient interest in the other.”19 Kindleberger wished that a more activist and understanding United States of the 1920s and 1930s had carefully shepherded the world into a new dollar-gold system, much as the world had been on a pound sterling-­ gold system prior to 1914. Nothing of the sort happened, as the United



States became preoccupied with “national macroeconomic management” (as Mundell put it in his 1999 Nobel Prize lecture) at the expense of attending to its responsibilities as the new leader of the international monetary and economic system. The result was the Great Depression. Those who could get cash did not invest or spend it but hoarded it—given that those who could wield economic leadership were indifferent toward or ignorant of the arrival of their noblesse oblige.20 In 1968, Mundell implied that one of the obligations of American leadership was to see that not everyone wanted it. There was some other, more organically derived monetary system that the world preferred over a dollar standard, however efficient on economic grounds that standard may have been proving. Mundell was uncovering, perhaps, the false notes that lay at the heart of dollar dominance. One of these, manifestly, was the American maintenance until recently of an enormous stock of official gold reserves. The basis of this stock was the domestic gold confiscation of 1933, a notorious act of policy desperation in the interest of “national macroeconomic management” at the depth of the Depression. President Franklin D. Roosevelt believed that the natural desire of the population to have a portfolio preference for gold in the incredibly straitened and high-tax circumstances of 1933 was a barrier to recovery. Federal authorities forced comprehensive gold sales to the government, from domestic owners, at a below natural market price. The consequent establishment of a prodigious official gold stock on the part of the issuer of the dollar, of Fort Knox itself, put in place one of the horns of the Triffin dilemma. The United States now had a gold hoard that could run out. Classically, such problems did not stalk specie standards. Currency, or “note” issuers in the nineteenth century, particularly issuers of dollars in the United States prior to 1861, did not maintain prodigious gold and silver reserves. They bought such things on the open market when they needed them for redemption requests. The tradition of large unitary currency issuers with enormous, not just specie but gold stocks emerged only in the late nineteenth century and became a uniqueness of the twentieth century as an adjunct of state authoritarianism. In the 1930s, the United States had forced its citizens to give up their gold. Then came a monetary system based on the result. The monetary order and system were cleaved from the beginning. The trouble would come eventually not from a domestic but a foreign source. As France acted, the untenability of the problem became inescapable with the events of 1967 and 1968.



The recommendations Mundell gave were not clearly consistent with his diagnosis. On several occasions, including in another thought-piece on “Paper Gold” for the AER in 1969 and in his 1971 book Monetary Theory, he threw in with new international accounting devices as a replacement for gold. He worked out an equilibrium economics for the IMF’s “Special Drawing Rights” (SDRs) that would, replacing gold, be the medium in which foreign authorities could redeem their excess foreign-exchange reserves. He would speak approvingly of the “forward-looking ideas” of the Bretton Woods Conference concerning a single world currency on the order of Keynes’s “bancor” and Harry Dexter White’s “unitas.”21 To be sure, within the professional class servicing the international monetary system, ideas along the lines of the SDR receive serious and dedicated consideration. The economics of SDRs may well be compelling in addition—Mundell had shown as much. What improvement SDRs would make (and have made) on the system that gave rise to Despres’s intermediation thesis is, however, not clear. That was a system that worked perhaps flawlessly, as gold became a passenger within it. But as Mundell pointed out, that system had to go because despite the demonstration of its flawlessness it had a weak connection with aboriginal political appeal. Since the late 1960s at its debut, when on rare occasions the SDR has been the subject of broad consideration as a new “world money” among the public, it has emerged as a laughingstock. The SDR has only “systemic” traits, and none pertaining to “order” on the Mundell definition. As he got involved with Laffer in the nascent supply-side revolution in the 1970s and 1980s, Mundell pulled back from advocacy of the SDR in favor, once again, of gold. “Gold Would Serve Into the 21st Century,” as he wrote in the Wall Street Journal in 1981. The stagflation crisis would undermine many assurances. Mundell’s friendship with Journal editorialist Jude Wanniski, a friendship brokered by Laffer, probably helped to push Mundell back toward gold. Wanniski knew the native appeal of gold, among the populace, compared to nil regarding the SDR. Wanniski gave phenomena of this type central place in his articulation of his “political model” in The Way the World Works (1978), the book that gave us the napkin story about the Laffer curve. In Wanniski’s political model, “the electorate is wiser than any of its component parts. Civilization progresses in a political dimension through the ability of politicians to read the desire of the electorate.”22 There is no “desire” on the part of the public, no matter the counsel of any professional class, for the SDR as world money. The public’s continual



irrepressible fascination with gold, and in the contemporary age to a notable degree with Bitcoin and cryptocurrencies, are pointers toward the actual monetary order in the Mundell meaning. Demonstrations on the part of professionals of the efficiency of a non-organic monetary system suggest the efforts of system to impose itself on order. Mundell taught that it is best for them naturally to match, for the architects of system to take their cues from and keep faithful to order. The events swirling around Laffer and Mundell in the late 1960s pertaining to their subject of study, the international monetary system, would, they could hardly have realized, occasion enormously fateful turns in their own professional careers and intellectual and policy relevance. The throttling of gold into a subservient, and after 1971 officially irrelevant position with respect to the dollar presaged an acutely dispiriting economic time of troubles, that of stagflation, which befuddled and embarrassed professional economics. In this new context, Laffer and Mundell took on the role of renegades and successfully rallied policymakers, in a manner essentially without precedent in the history of expert influence, to institute an approximation of the Bretton Woods status quo ante with the President Ronald Reagan-era reforms of the 1980s. Laffer and Mundell’s own bewilderment at the state of affairs in the late 1960s was an important basis for this development. These two economists both were certain, in the late 1960s, that careening toward some new monetary system—recommended as it may have been at large in the field international economics—of fiat dollars and floating rates was wildly inappropriate. The effective defeat of their ideas in policy in the late 1960s and early 1970s presaged their taking ideas to policy in the latter 1970s and the 1980s. Mundell’s distinction between system and order is instructive as well concerning the major slur that has come the way of supply-side economics over the years, targeting certainly Laffer and not exempting Mundell. This is that supply-siders, like advocates of the gold standard, are “cranks.” Their ideas for some reason stopped making it in academia, so Laffer and Mundell joined up with hoi polloi who by nature have weird, unprofessional ideas about economics. Perhaps more accurately, the distinctly populist appeal of the message of the Mundell-Laffer team in the supply-side era should be seen as an attempt to bring together at long last the imperatives of order with the design of system. The charge of being a “crank,” in this context, perhaps was not substantive, but rather was a term employed in a professionalist agenda on the part of the agents of a deracinated system to assert its privileges against and independence from order.



Tenure Laffer kept churning out product in the journals and in conferences in 1969 and 1970. His chief publications were a pair of articles confirming monetary endogeneity and casting doubt on the usefulness of the typical money-supply aggregates—and, therefore, on monetary policy itself. In February 1969, a brief (three-page) article of his appeared in The Review of Economics and Statistics. It concerned “Vertical Integration by Corporations, 1929–1965,” had a hidden monetary twist, and again vindicated the processes of the received economy against dedicated efforts at governmental regulation and policy. He wrote that “when the surface of an economist is scratched we generally find a belief that vertical integration in the corporate sector has increased during the past few decades, if not longer.” Laffer proposed a new measure of the phenomenon and offered that “the conclusion reached on the basis of this empirical evidence is that there has not been any discernible increase in the degree of vertical integration in the corporate sector.” In his work to date on the monetary system, Laffer’s standard observation was that the current moderately regulated process was working out for the best. He was now proposing similar conclusions in major areas of the economy without explicit, but with an implicit, reference to the monetary system. He was cementing himself, in his Chicago assistant professorship, as a free-market advocate and certainly an economic conservative. The status quo, once again, in his analysis was yielding beneficial results and not calling out for reform. Moreover, in his article on vertical integration, he tried out new methods of econometric technique, suggesting that his research interests might continue to include topics outside the ordinary confines of the field of the monetary regime.23 In the brief article, which he referred to as a “note,” Laffer established an index for corporate vertical integration. This was corporate sales over gross corporate product. The higher the ratio, the less vertical integration. If corporations were making sales at a high level in proportion to final goods, integration was lacking. He examined ten industry groups from agriculture to services and found this ratio to have slightly increased, and with a degree of consistency, to just past the level of 2.8 over the 35 years to 1965. (The rough comparison today is the ratio between gross output and GDP; in 2019 in the United States this was approximately 1.75, perhaps  signaling an increase in vertical integration since 1969.) The data Laffer called on largely came from the National Income and Product



Accounts of the United States (NIPA), the first time he would call on this source. As a tax-policy economist in the upcoming decades, he would offer the data of the NIPA as the chief vindication of his supply-side model. The distinction this article made—between the ratio of gross and final sales—had monetary significance. Gross sales required liquidity to clear and therefore, since large as a percentage of gross product, represented a major input for the demand for money. Any monetary policy geared toward final sales, or GDP or GNP, would miss a major component of, as Laffer put it in his next paper, “the money market.” As he published the vertical integration piece in early 1969, Laffer was preparing an article for publication in the Chicago-housed journal that Mundell edited, the Journal of Political Economy (JPE) on “Trade Credit and the Money Market.” It came out in the spring of 1970. Here Laffer incorporated the theme of the vertical integration paper and made it pertinent to the practices of monetarism. He proposed that trade credit—inter-business purchases of goods on delayed payment, the stuff of gross less final corporate sales—represented a substantial portion of the real money supply. As Laffer worked out the equations and data in this longer (twenty-eight-­ page) article, he found that conventional estimates of the money supply, which did not take credit into consideration, undercounted it by nearly half. The item he assessed in greatest detail was “unutilized trade credit,” or trade credit on which regular business buyers could rely. Because of the size and extent of trade-credit conventions and facilities, Laffer observed, for many business buyers “there is no need to possess an intermediary commodity—demand deposits and currency—in order to acquire goods and services.”24 In making such an observation, Laffer questioned, implicitly, the standard monetarist regard for such things as demand deposits and currency as good approximations of monetary aggregates. He was getting to know Milton Friedman, the progenitor of monetarism, well at Chicago, and in the article he cited Friedman’s work approvingly in several places. Within a year—when the model Laffer built for the Office of Management and Budget became a press and policy sensation—one of its chief characteristics was the assured way in which it dismissed a main tenet of monetarism, the belief that “leads” and “lags” were at play in the effects of monetary-­ policy changes. In the JPE article, Laffer outlined his first set of claims of how monetarist aggregates, and presumably therefore monetarist-inspired policy, lacked empirical validity.



Consistent with essentially everything he had written to date, “Trade Credit and the Money Market” was another vindication of the status quo over further policy intervention. As Laffer wrote in this article, “Because unutilized trade credit available is a very close substitute for bank money and is not regulated, policy measures attempting to change bank money are to a large extent offset by changes in unutilized trade credit available.” The marketplace had its ways of circumventing policy. Efficiency therefore required that policy remain modest. In his review of the Jerome Stein AER article three years before, he had made a complementary point. This was that the would-be reformers who saw instability in the fixed-exchange-rate currency system in their soup, as it were, were mistaking healthy, self-adjusting capital movements for a harbinger of crisis. In that early case, “first, do no harm” was the counsel.25 In March 1970, Laffer traveled with any number of Chicago colleagues, including Mundell and Johnson, to Madrid for a conference on common currencies. Mundell was a compulsive conference organizer—Fritz Machlup dubbed him “Robert the Convener”—and had called this meeting. It turned out to be a fateful one. The papers Mundell gave were the outlines of the European common-currency area that earned him the nickname “the father of the euro.” In 1968, Mundell had said that a reason for the recent French action was the fact that “a common European currency was not yet in existence.” That French action, in Mundell’s telling, had a particular aim and had not been successful in achieving the result. The particular aim was to weaken the pound and the dollar so as to salvage gold as the premier global monetary unit. The moves in this vein backfired, in that the appreciation of gold made it useless as a currency on the grounds of Gresham’s law, which Mundell cited in this context. Therefore, momentum shifted in favor of developing a European currency. In Madrid, Mundell was at the ready to sketch the equilibrium economics that such a monetary unit could bring. Laffer’s was the lead paper in the proceedings, which came out three years later, and the subject of extensive remarks from two dedicated commenters and Johnson and Mundell as well. This paper, “Two Arguments for Fixed Rates,” indicated that Laffer was acquiescing to the emerging condition that he had been fighting since his AER debut in 1967. Originally, in his scholarship, Laffer strove to defend fixed rates in their status of ubiquity. As of 1970, he was shifting toward recommending fixed rates as opposed to defending them. The British devaluation and the



“ghosting” of gold (as Mundell would all but put it) by the dollar suggested that a regime of widespread floating was in the making.26 The first of “Two Arguments for Fixed Rates” that Laffer made concerned employment. He offered an example “in a Keynesian type of system” of a small price-taking country in which, under flexible rates, the government decreases the domestic money stock. There will be unemployment, interest rates will rise, investment will decline, and the currency will appreciate. These results will “tend to reduce the physical volume of domestically produced goods sold to foreigners. All these forces operate to further the decline in output and employment beyond what would have occurred had the exchange rate not been free to move.” He affirmed, “Again in a Keynesian type of system, fixed rates will be associated with less unemployment than will flexible rates.”27 He explained further: “The marginal unemployment ‘costs’ of not having enough money should be equilibrated across countries under a fixed rate, not a flexible rate, system. Under deflationary pressures money will tend to reside where it has the greatest employment effects. … A flexible exchange rate system has, in fact, a governmental restraint imposed, whereas a fixed rate system has an additional degree of flexibility, i.e. the trade in money.” Concerning the two systems “commonly thought of as analytically identical”—flexible rates with rigid prices and fixed rates with flexible prices—his conclusion was stark. Laffer wrote: “With flexible exchange rates and rigid prices, the real as well as the nominal stock of money is determined by the government. … Unemployment may be forthcoming as described above. With fixed exchange rates and price level flexibility, however, the real, as well as the nominal money stock is perfectly elastic. Unemployment, as a result of monetary phenomena, should not exist.” During the long era of floating rates still prevailing today that first took hold in the early 1970s, a central argument in its defense has been the beneficial degree of “autonomy” that floating rates confer to national monetary authorities. At the outset in 1970, Laffer cautioned that any perceived national autonomy under flexible rates was a false autonomy. The only freedom a government currency-issuer has under flexible rates is to choose among mistakes. The chance, as a solitary decision-maker, that it will get things right is small if not negligible. Under fixed rates, in contrast, all global currency issuers affect the money supply in any one country. If one country is too loose or too tight, currency flows into or out of the country occur at par to adjust conditions back to level. Rather than



guaranteeing a useful autonomy in each national case, flexible rates diminish the autonomy of the many, of numerous global currency producers that can bring money into, or take money out of, countries that require changes to their money supply. To close his article Laffer specified his second argument. He wrote, again starkly, “By having a monopoly of the domestic money supply and by not fixing the exchange rate, the central bank is effectively prohibiting the international trade in money.” Under flexible rates, the currency producer declines to define its product. One does not know what one is getting in buying it. To exchange a currency with a known and substantive definition with another is the essence of fixed, but not flexible rates. Laffer spun out his argument: “Qualitatively the effects of the prohibition of trade in money are the same as the effects of the prohibition of trade in any commodity. Quantitatively, however, the effects probably are greater than with most other commodities. … Money is … most nearly costless to arbitrage in time and space. Flexible exchange rates impose a severe cost on the arbitrage of money across national boundaries. The second reason focuses on the unique role of money in controlling the level of output and employment in an economy.” National central banking institutions and unitary national currencies— these were still developments barely a hundred years old, at least in the United States, in 1970. Again prior to 1861 (in the “Two Arguments” piece Laffer reprised his citation of Jeffrey Williamson from the “Anti-­ Traditional” paper), the federal government restricted itself to defining the currency, as weights of specie. Currency was issued domestically by innumerable private banks. In that system, there was arbitrage to discover the most efficient producer. If floating rates were to arrive generally after 1970, the two classical elements of the currency system of the early industrial revolution would no longer exist. There would be no definition of money, and the multiplicity of issuers of the monetary product would devolve to one. Laffer believed that the efficiency losses to the economy had to be considerable. As he wrote in conclusion, “Under fixed exchange rates money is a tradable commodity like any other good. The government, by fixing rates, is in fact removing the very distortion it imposed by prohibiting the private production of money.” This was an economics of the longue durée. Laffer was reflecting on the ultimately 110-year process, from 1861–1971, of the elimination of innumerable issuers of a common currency. Domestically in the United States, this arrangement had prevailed in the “free-banking” years prior to the civil war. Under fixed rates and the gold



standard in the latter portion of the era, a simulacrum of these innumerable private domestic producers of currency emerged in the form of various governments of the world taking on sovereign currency-issuing power and exercising it under the auspices of fixed rates. Now with flexible rates there was to be only one currency issuer in any economy that could, in practice, make the local fungible money. It was to be a new straitened world, and Laffer had doubts about its prospects. In his envisioning of a European common currency, Mundell made concessions to the geopolitical status quo to which Laffer was himself not prepared to acquiesce. With a European common currency, the number of currency producers globally would shrink radically. Perhaps in the future there might be just two or three, the United States, the European community, and perhaps some other contemporary hegemon. Laffer was harking back in 1970 to a world rapidly receding from view, that of a wide multiplicity of currency producers. In making his argument for fixed rates, Laffer was asking the officials of the global economic powers to remember where their economies had come from, namely internal currency competition. The idea that privately issued money in its heyday could lack definition, could “float” was preposterous. If some nineteenth-century bank issued paper money with no definition, it was liable to be shunned completely. The coming of flexible rates, Laffer all but saw in 1970, was a sign that state authority in the global economy was at an apex. That academic year, 1969–1970, Laffer got a surprise from his institution, the faculty of the University of Chicago Graduate School of Business. He was awarded tenure and given a promotion to associate professor, effective the next fall. Ordinarily after one’s second-year review on the tenure-track of this faculty, an assistant professor was given one of two contracts. Either the junior professor was given a two-year contract with no chance for tenure, or a three-year renewal with tenure consideration after a total of five years, both of which left rank unchanged. Laffer was simply tenured and promoted. He was “born with tenure,” George Shultz, the dean through 1968, recalled George Stigler’s telling him at the time.

Notes 1. Arthur B. Laffer, review of The Economics of Cycles and Growth, by Stanley Bober, AER 58, no. 4 (Sept. 1968), 1006–1007. 2. Ben S.  Bernanke, “On Milton Friedman’s Ninetieth Birthday,” Nov. 8, 2002, Federal Reserve Board, Conference to Honor Milton Friedman, University of Chicago, Chicago, Illinois,



3. For a discussion, see Kudlow and Domitrovic, JFK and the Reagan Revolution, chs. 1–2. 4. Robert M. Solow and James Tobin, “Introduction,” in Two Revolutions in Economic Policy: The First Economic Reports of Presidents Kennedy and Reagan, eds. Tobin and Murray Weidenbaum (Cambridge, MA: MIT Press, 1988), 6. 5. Robert Mundell, “On the History of the Mundell-Fleming Model,” IMF Staff Papers 47, Special Issue (2001), 222; Kudlow and Domitrovic, JFK and the Reagan Revolution, 90–91. 6. Ross B.  Emmett, “Sharpening Tools in the Workshop,” in Building Chicago Economics: New Perspectives on the History of America’s Most Powerful Economics Program, eds. Robert Van Horn, Philip Mirowski, and Thomas A. Stapleford (New York: Cambridge University Press, 2011), 94, 109, 112–13. 7. Max Corden et  al., “Harry G.  Johnson (1923–1977): Scholar, Mentor, Editor, and Relentless World Traveler,” American Journal of Economics and Sociology 60, no. 3 (July 2001), 625; Dornbusch, “The Chicago School in the 1960s.” 8. Laffer, “An Anti-Traditional Theory of the Balance of Payments Under Fixed Exchange Rates.” 9. George H. Borts to Laffer, Aug. 22, 1969, Laffer archive. 10. Peter B. Kenen to Joe Pechman, July 31, 1968; Salant to Laffer, Nov. 19, 1968, Laffer archive; Arthur B. Laffer, Private Short-Term Capital Flows (New York: Marcel Dekker, 1975). 11. Laffer to McKinnon, July 3, 1968, M file, Laffer archive. 12. For a review of the 1967–1968 events, see Robert M.  Collins, “The Economic Crisis of 1968 and the Waning of the ‘American Century’,” American Historical Review 101, no. 2 (April 1996), 396–422. 13. Laffer, “The U.S. Balance of Payments,” 43. 14. Laffer, “The U.S. Balance of Payments,” 46. 15. Mundell, “The Collapse of the Gold Exchange Standard,” 1125–26. 16. Mundell, “The Collapse of the Gold Exchange Standard,” 1131–33; “A Reconsideration of the Twentieth Century,” AER 90, no. 3 (June 2000), 332; “The International Monetary System in the twenty-first Century: Could Gold Make a Comeback?” Lecture at St. Vincent College, Latrobe, Pa., March 12, 1997, Elsewhere Mundell referred to the “episode” remark as Sir Roy Harrod’s, as in Mundell, “The Monetary Consequences of Jacques Rueff,” Journal of Business 46, no. 3 (July 1973), 393. 17. Despres et al., “The Dollar and World Liquidity,” 528–29.



18. Brian Domitrovic, “Montesquieu and the Monetary System,” Public Discourse: The Journal of the Witherspoon Institute, May 30, 2019, www. 19. Charles P.  Kindleberger, The World in Depression, 1929–1939 (Berkeley: University of California Press, 1986), 299. 20. Mundell, “A Reconsideration of the Twentieth Century,” 339. 21. Mundell, “A Reconsideration of the Twentieth Century,” 332. 22. Robert A.  Mundell, “Gold Would Serve Into the 21st Century,” WSJ, Sept. 30, 1981; Wanniski, The Way the World Works, 3. 23. Arthur B.  Laffer, “Vertical Integration by Corporations, 1929–1965,” Review of Economics and Statistics 51, no. 1 (Feb. 1969), 91. 24. Arthur B.  Laffer, “Trade Credit and the Money Market,” Journal of Political Economy 78, no. 2 (Mar.–Apr. 1970), 240. 25. Laffer, “Trade Credit and the Money Market,” 257. 26. Robert Mundell, “The Euro and the Stability of the International Monetary System,” January 1999, lux.html. 27. The quotations from this source in the following paragraphs are from Laffer, “Two Arguments for Fixed Rates,” 28–34.


“A Formal Model of the Economy”

In May 1970, the Journal of Finance ran an article that Laffer had first seen in draft when its author, Eugene F. Fama, had put it in faculty mailboxes at the University of Chicago School of Business as Laffer was arriving on campus in the fall of 1968. Laffer marked up the paper and soon was collaborating with this pioneer of “efficient markets theory.” The two would co-author two articles, one on information and the capital markets for a 1971 issue of the Journal of Business and another on the number of firms and competition for a 1972 issue of the American Economic Review. Fama’s classic statement of the efficient market concept is, surely, his 1970 Journal of Finance article on “Efficient Capital Markets: A Review of Theoretical and Empirical Work.” Among the ten colleagues Fama thanked in the acknowledgements of this article, including Michael Jensen and Merton Miller, Laffer was mentioned first and well out of alphabetical order.1 That summer, Shultz, who in 1968 had left the deanship at the School of Business to become the secretary of labor in the incoming Nixon administration, took on a new role, in the executive office of the president. He switched from heading the labor department to becoming the first director of the Office of Management and Budget (OMB), the successor of the Bureau of the Budget. As he took this position, Shultz asked Laffer if he would join him on staff as the agency’s economist. Laffer accepted.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 B. Domitrovic, The Emergence of Arthur Laffer, Archival Insights into the Evolution of Economics,




His title would be the “Economist” of the OMB. He would begin work, on leave from Chicago, in September. As he prepared to go to Washington, Laffer determined that he should come to government with a specific contribution from the world of academic economics. The currency economics he had been working on were not directly applicable to the mandate of the OMB. Moreover, the Nixon administration was proving cool to all aspects of the Bretton Woods system, from exchange-rate fixity to the dollar anchor in gold. Thinking of his budding work, and long hours of conversation, with Fama (to whom Laffer remembers being regularly second when it came to who showed up at the office the earliest every day), Laffer decided that he would apply efficient markets theory in some potentially useful way as the OMB economist. The project he settled on was a model. He would test against the evidence, for the OMB, the two reigning macroeconomic paradigms, the monetarist and the Keynesian, along with the rising challenger, efficient ­markets theory. Laffer’s first assignment at the OMB was to accompany Shultz on an extensive trip concerning economic policy to Southeast Asia, including to South Vietnam, in September 1970. On that trip, which served as prep-­ work for the China rapprochement of 1972, Laffer became acquainted with domestic affairs adviser John Ehrlichman, who would become one of his dearest mentors in Washington. In October, Laffer settled in at his office in the Executive Office Building, near that of the vice president. As his own associate and econometrician, he brought with him R.  David Ranson, a graduate student and teaching assistant of his from Chicago. Laffer and Ranson set to building their model, which they would call “A Formal Model of the Economy.” Its purpose, as they put it on writing it up in December, was “hypothesis-testing.” They wanted to see how the representative variables of monetarism and Keynesianism, and those of efficient markets, fared in correlating with major macroeconomic outcomes. The results could be interpreted as offering a provisional statement about which of the major macroeconomic theories proved superior in terms of explaining the recent course of the American economy. As for choosing the variables, the “preselection of variables,” as Laffer and Ranson put it in the summary of their model, this “was based upon their a priori relevance in simple Keynesian, Quantity Theory, or Efficient Markets models …. In order to represent a Keynesian-type model, we considered both the current and lagged values of government purchases of goods and services, government receipts, and budget outlays. For a



Quantity Theory position, we considered current and lagged values of two money supply variables”—the M1 money stock (referring to the sum of cash and liquid checking accounts) and the M2 money supply developed by Milton Friedman (which adds to M1 semi-liquid funds such as money-­ market accounts). For efficient markets, Laffer and Ranson chose the Standard & Poor’s 500 stock index and the three-month treasury-bill interest rate as the representative variables.2 In such a way the Laffer-Ranson model aspired to test the defining elements of the major macroeconomic traditions. Changes in the money supply at various time lags and leads with respect to the major macroeconomic outcomes would test the relevance of this core measure of monetarism. Changes in government receipts and spending in total were the chief discretionary components in the Keynesian adjustment of aggregate demand as policymakers pursued macroeconomic goals. The standard stock-­market index and interest rate tested efficient markets. The core elements of each respective tradition became the independent variables in the model. The authors added several more independent variables that were not closely related to the two traditions, such as hours lost to strikes. A total of twenty some independent variables, inclusive of lagged values (of a quarter to one year) of changes in the money supply and government spending, plus stock values and interest rates,  and using raw as opposed to seasonally adjusted data when available, with their respective coefficients made up one side of the equation. On the other side was one of four major macroeconomic statistics. These were changes in nominal gross national product (GNP), real GNP, the inflation rate, and the unemployment rate. These dependent variables, changes in nominal and real GNP, plus inflation and unemployment, were available for the United States in quarterly series beginning in 1947. There were ninety-two total possible observations through 1969, with data lacking in certain cases in the periods prior to the conclusion of the Korean war. Laffer and Ranson put in logarithmic values of the independent variables over all the observations and reduced the variation of each logged variable by means of least squares. They then equated the logged dependent variables with the corresponding plot of reduced and logged independent variables, eliminating those that did not contribute to a tighter fit. A regression emerged in which four independent variables remained as the best expression of the dependent variables, especially GNP.  These independent variables were the current money supply, current government purchases, the lagged stock index, and the lagged interest rate. Numerically, the authors found that these four



independent variables correlated to changes in real and nominal GNP within a range of 1 percent.3 The authors offered several interpretations of their results. First, “fiscal policy, as represented by federal government purchases of goods and services, provides a temporary stimulus to the level of GNP.” The regressions had government purchases raising GNP dollar-for-dollar in the period in which they occurred, with the effect quickly dissipating. “After three quarters, the cumulative effect is insignificantly different from zero.” Second, “monetary policy … has an immediate and permanent impact on the level of GNP …. Every one percent change in the money supply is associated with about a one percent change in GNP.” Again, the effect was permanent. There was no waning of GNP after a temporary fillip as with government purchases. The third and final major positive correlation was that both “the Treasury bill rate” and “movements in the S&P index provide reliable information with respect to future changes in GNP. The average lag” for the latter “is approximately three months.”4 Several conclusions were conspicuously difficult to derive from the results. These concerned affirmation of the core ideas of Keynesianism and monetarism. When it came to Keynesianism, there was no fiscal multiplier to speak of. The supposed engine of the fiscal multiplier, government purchases, increased GNP only by their own amount and in the period in which they occurred. Afterward, there was a slight, declining multiplier effect that vanished after a year’s time. As for monetarism, the lagged money supply had no purchase—a violation of a central principle of Friedman’s. Only the current money supply correlated with fitness to the macroeconomic outcomes, supporting the idea that the money supply was not exogenously but endogenously determined. Efficient markets theory, in contrast, remained a possibility given the correlation of stock prices and interest rates to forthcoming GNP. The hypothesis test Laffer and Ranson set up had run its course. Efficient markets retained provisional validity with respect to GNP outcomes, while Keynesianism and monetarism lost any which they may have had. Laffer and Ranson devoted the initial pages of the presentation of their model, in the written versions they produced in late 1970 and in 1971, to a brief discussion of model classifications. They explained that in constructing a model whose chief purpose was to test macroeconomic hypotheses against macroeconomic results, theirs was neither a model emphasizing forecasting or simulation. Forecasting models were by design “ex ante” models, models whose central purpose was to estimate what



outcomes will arise in the future. Theirs was “ex post”—it investigated macroeconomic outcomes after they had occurred, so as to assess relationships between those outcomes and potential inputs. A simulation model, for its part, sought to describe the economy in whole, especially the interrelationships of its numerous components. Laffer and Ranson identified the major examples of the models in the alternative classifications they had in mind. These were the recently completed St. Louis Federal Reserve model as a hypothesis-testing and forecasting model and the Lawrence Klein “Wharton” model as a simulation model. The Laffer-Ranson model appears to have taken some inspiration from the St. Louis model, first presented by authors Leonall C. Andersen and Keith M. Carlson earlier in 1970 as a test of Keynesian versus monetarist principles, vindicating the latter. This model explicitly strove to cull the number of potential independent variables down to those that were crucial for their respective economic theories. As Andersen and Carlson wrote introducing their model in April, “one of the chief advantages of this model is that it depends primarily on information about only two variables—the money stock and high-employment expenditures.” Therefore, they added, “it is not suitable for exact forecasting.” But the title of their article—“A Monetarist Model for Economic Stabilization”— indicated that it had policy and forecasting and aspirations.5 The Wharton model and the Data Resources model developed by Otto Eckstein, both of which had come into being in recent years, were major examples of the simulation variety. Laffer and Ranson cited Klein’s estimation procedures several times in their paper. The Wharton model was a prototypical simulation model by virtue of its complexity. It had innumerable inputs from wages and salaries to demographic details to industry-­ specific data. Its purpose was in part to forecast macroeconomic outcomes such as GNP. It found its greatest use, however, in business planning and fiduciary responsibility. Corporations using the Wharton model found that its specificity enabled market, cost, and liability assessments that an economic model (such as the St Louis) emphasizing the largest outcomes such as GNP could not. It was telling that these simulation models eventually found buyers in the marketplace that valued the models in the hundreds of millions of dollars. Laffer and Ranson followed the example of the St Louis model of earlier in 1970 and isolated the classical variables of each competing macroeconomic tradition, reserving maximal inclusion of variables to the simulation models favored by businesses facing specific market challenges



and opportunities. The crucial difference between the St. Louis model and the OMB “Formal Model of the Economy” turned on the seasonal adjustment of data. As a matter of course, the St. Louis model called on seasonally adjusted data, in particular for nominal GNP and the money supply. Laffer and Ranson were concerned that seasonal adjustment would obscure one of the crucial issues in the testing of monetarist doctrine, as well of that of the Keynesian fiscal multiplier. This was the matter of lags. If monetary (or fiscal) policy did or did not have a lagged effect on GNP— and the long and variable lag in the effect of monetary policy was a staple of Friedman’s—raw data would reveal the matter most clearly. “For the purpose … especially of hypothesis testing,” Laffer and Ranson wrote, “seasonally adjusted data are inappropriate for several reasons.” For example, “through smoothing” such data can “remove some of the behavioral covariance in the guise of seasonality,” it can “introduce autocorrelation” and lead to losses in the “degrees of freedom” of data in a sample. Laffer and Ranson argued that if a central matter in testing a theory concerned lags, concerned the timing of effects, it was crucial to use unadjusted data. As Laffer and Ranson presented their model internally within first the agency of the OMB and then the Executive Office of the President more broadly in December 1970, they indicated that they knew they were drawing lines that would occasion opposition. In one passage, they stated that “inferences from the OMB model as to the outcome with, say, an 8 percent growth in the money supply, or other extreme observations, may be highly unreliable.” This statement was made in full knowledge that since the summer of 1970, the Council of Economic Advisers (CEA) had been gunning for 8 percent money growth to bull the country out of the recession that had hit in December 1969 and lingered through the first months of 1970. More ominously, in December 1970, as OMB submitted the model to CEA chair Paul McCracken for his review, Laffer and Ranson inserted an epigraph in their written presentation of the model. It was a quotation from Bertrand Russell’s Unpopular Essays and went as follows: Persecution is used in theology, not in arithmetic, because in arithmetic there is knowledge, but in theology there is only opinion. So whenever you find yourself getting angry about a difference of opinion, be on your guard; you will probably find, on examination, that your belief is getting beyond what the evidence warrants.



If Laffer and Ranson had a sense, late in 1970 as their model was about to go public, that in hypothesis-testing via the presentation of numbers they would court testy responses, the great ruckus that would soon arise around their model would prove it justified.6

1065 Comes to OMB George Shultz had been a natural choice for secretary of labor. Labor relations were his academic specialty. Shultz held a Ph.D. in industrial economics, like Mundell, from MIT.  In his research, he had worked with other scholars in concert with representatives of industry and labor in inquiry into the theory and best practices of bargaining. His economic conservatism, and perhaps even his affinity for forthcoming supply-side economics, was discernible in his publications. In a work from 1963, for example, he noted that among the essays he had edited, “it appears from these papers that the problem of cost-push inflation receives more attention than it deserves and the allocation-of-resources problem far less.” Cost-push inflation was a darling argument of the New Economics justifying wage-price “guideposts” (as they were called in the Kennedy CEA). The idea was that if labor got a raise, employers would have to increase prices, and this is where inflation came from. Federal “guidepost” suggestions would specify limits on wage and price hikes in each industry, and cost-push would be slowed. In contrast, resource-allocation problems concerning Big Labor involved such things as the disruptions that contracts could cause to the natural division of capital and labor in an industry. When Mundell complimented Laffer’s 1970 paper on fixed rates, he pointed out its relevance regarding the efficiency of resource allocation.7 One of Shultz’s priorities as labor secretary was to de-federalize negotiations processes. In a notorious recent example, preceding his Yale commencement address, Kennedy had tried for months in 1961–62 to negotiate labor-management peace in the steel industry. He thought he had an agreement, only to have the major producers raise prices after they pocketed wage concessions. Kennedy got so furious that he was quoted using profanity by the New York Times. One of the purposes of the Yale address was to assuage effects of the recent assaults that he had made on business executives, in particular chairman Roger Blough of the United States Steel Corporation, who was in attendance as Kennedy spoke at Yale. As he became secretary, Shultz indicated to labor and management that they were on their own, that visits and attention from high government



officeholders were not to be anticipated. Shultz did not have to deal with a major strike during his year as labor secretary. The momentous event that the department faced that year was the murder, by inside political opponents, of United Mineworkers presidential candidate Jock Yablonski at New Year’s 1970. After this incident, the department became more active in pursuing trade-union corruption. In May 1970, Congress acted on a commission recommendation and changed the Bureau of the Budget (BoB) into a new entity, the Office of Management and Budget (OMB). The charge of the new OMB was both to prepare the president’s yearly budget request and to assume prerogatives currently held by department secretaries and recommend budget priorities in view of best practices in management theory. Shultz had built a distinguished career in the field of optimizing labor-management negotiations and had impressed the president with his demeanor. Nixon picked him to succeed Robert Mayo, the last head of the BoB. One of the tasks Shultz gave his “Economist,” Laffer, was to come to his office and give him economics lectures. Shultz wanted to keep up with the latest economics and the unconventional perspective Laffer maintained with respect to it. Laffer remembers in particular giving Shultz a lecture on trade, going over the points of the “Anti-Traditional” paper. Shultz, the personification of “gravitas” according to all accounts, may have been concerned about the condescension to which he was the subject from the president’s other top economic advisers. As historian Allen J. Matusow has written, CEA members Herbert “Stein and McCracken had known Shultz for years …. Nonetheless, though its members admired Shultz for his ability as a manager, there was no joy at the CEA on his ascendance. Untrained in macroeconomics, Shultz had done his professional work on labor. In the CEA’s view, Shultz lacked the professional qualifications for the role of Nixon’s chief economic adviser”—which he had a bid on becoming as director of the OMB.8 A chief role of Laffer’s, therefore, at OMB, was to supply Shultz with an economics whose sophistication could match that of the CEA, in the interest of the OMB’s policy positions. These were conventional conservative positions. Shultz wanted yearly federal expenditures not to cross the revenue level that would come with a full-employment economy and preferred a budget surplus (such as had come in 1969). He wanted regular, moderate monetary policy from the Federal Reserve and was cool toward devices that could cover for irregularity and looseness such as wage and price controls. And he wanted a healthy economic expansion free from



inflation. If these goals might appear contradictory to the macroeconomic set in the White House, if not the macroeconomics profession at large, he had a hot young economist he knew well from Chicago who could justify his expectations. The reputation of the new Nixon administration with respect to the economy had taken a major blow in 1969 and 1970 with the first recession in eight years. Like clockwork, when Nixon was at or near the head of the administration, the economy soured. When he was vice president from 1953–61, there were three recessions, the last concluding in February 1961, Kennedy’s first full month as president. From that point on, there was sustained economic growth at a prodigious rate of 5 percent per year. Then not twelve months into Nixon’s presidency in December 1969 came the next recession. By May 1970, the stock market was down by a third compared to when Nixon had been elected, as unemployment was crossing the 4 and then 5 percent thresholds en route to over 6 percent by the end of the year. In 1969, the inflation rate was also at 6 percent, easily the highest of the decade. The major responsibility of the CEA is to prepare the Economic Report of the President, released early each year. The 1970 report of that February had a chastened and timid tone. In his introductory message, Nixon explained the dilemma he faced. “In the first half of the 1960s,” he wrote, “we did have price stability—but unemployment averaged 5½ percent …. In the second half of that decade, we did have relatively full employment— but with sharply rising prices.” He affirmed that “if we … add a new realism to the management of our economic policies, I believe we can attain the goal of plentiful jobs earning dollars of stable purchasing power.” In its extended portion of the report, the CEA conceded that its “objectives of policy for 1970 … to reduce the rise of prices and to revive the growth of output” were “difficult to reconcile.”9 The trouble that came to the nation that May, as the recession met the extraordinary unrest, including the killings at Kent State University, that attended Nixon’s announcement of the invasion of Cambodia, conferred the sense that the Nixon administration was perhaps not managing decline so much as courting disasters foreign and domestic. As Matusow has related, the “Cambodian spring” left the CEA leadership “deeply shaken” and bent on doing more to improve the nation’s fortunes. The choice that CEA made was to dispense with the small-scale goals and indecision that had characterized its economic-policy orientation to date in favor of bold



new outlines of what the administration might accomplish in terms of the economy.10 The chief item in this effort was the articulation of an ambitious course for the economy over the next several years. This was something the CEA called the “optimum feasible path,” the term emerging in CEA memoranda that June and guiding CEA discourse through the presentation of the Economic Report of the President the following January. The optimum feasible path was a course of high growth, coupled with declining unemployment and possibly inflation as well, that could be achieved, in CEA’s view, if the administration pursued creative new policies. Technically, the optimum feasible path represented a real economic growth rate of 6 percent per year, with unemployment nosing back down to around 4 percent in time for the 1972 election. As a CEA memo set it out in June 1970, “CEA has traced a new optimum feasible path aimed at bringing the economy back to an acceptable rate of unemployment around the middle of calendar 1972 …. The basic statistics behind this optimum feasible path are shown in Table 1.” The table gave quarterly Gross National Product (GNP) numbers for each year from early 1970 through mid-1972. The calendar 1971 numbers amounted to a GNP for that year of $1070.5 billion.11 Over the summer and fall, CEA talked with all manner of executive office and Federal Reserve officials about strategies for achieving such a goal—a nominal economic growth rate of perhaps 9 percent as the recession still lingered that summer. CEA let it be known that it wanted a boldness of economic vision, and therefore in policy as well, for the recession to be shaken and 1960s-era growth rates restored. As McCracken told Nixon that August, as he referred to the optimum feasible path, “the economy will not, however, trace out anything like this more ambitious path if it and economic policy simply ‘rock along’”—“rock along” being the epithet McCracken used repeatedly to characterize the current policy trajectory. Two months earlier, McCracken had cautioned Nixon that unless the Federal Reserve got looser, even a “basic” path was unattainable. An “optimum” path would require still more dedicated policy changes and reorientation. He advised Nixon, in August 1970, that his top policy officials should ask themselves, “What is the path for the economy in the year ahead that we would deem to be optimum?” and “What are the implications of this for economic policy?”12 Generally, CEA recommended three proposals to bring the economy onto the optimum feasible path. Above all, it wanted substantial



money-supply growth, specifically of 8 percent, from the Federal Reserve. Citing the new St. Louis model, CEA held that this growth, of 8 percent, was necessary to achieve the real 6 percent economic growth incorporated in the 1070.5 GNP goal. The other major proposal was a full-employment budget. This is a budget that would be in balance if the nation were at full employment. (The budget had been in surplus in 1969 as the recession came on.) In addition, within the budget CEA prioritized liberal spending on housing. This probably indicated a belief on CEA’s part that the economic multiplier from housing spending was distinctly large. After a General Motors strike that lasted nearly two months from September to November, and a weaker GNP outlook for the second half of the year, CEA reduced its optimum feasible path for 1971 to $1065 billion in nominal GNP. As it prepared the Economic Report of the President for its January release, it worked with OMB, which was to release the budget at the same time, to ensure that all the executive agencies were proceeding from common assumptions. On December 17, McCracken expressed to Shultz, “I propose that for the purpose of settling on budget receipts estimates we use the following projection of the path of the economy which is desirable and feasible.” The nominal GNP figure he offered for calendar 1971 was $1064 billion. At this point, the Laffer-Ranson model, which the authors had just completed, began to circulate within the administration. The week before, CEA member Stein had gone over it and by the end of the month McCracken would have as well. Laffer and Ranson fed in the optimum feasible path and found that the goal of $1065 billion was attainable for 1971 GNP.  Given the postwar-era precedent, there were conceivable money supply and government expenditure values, and levels of the stock market and the treasury-bill rate, for 1971 consistent with this result. Crucially, the Laffer-Ranson model indicated that 6 percent money growth would be the level necessary for the GNP number. The CEA had been insisting upon 8 percent since the summer and remained steadfast on this issue in December. Given that it had called on the St. Louis model in working out the policy configurations that could bring the optimum feasible path, CEA believed that lags in the effect of monetary policy on output meant that money growth had to be quite large for the attainment of the optimum feasible path. Knowing that Shultz was cool to loose monetary policy, and getting word that the OMB model saw 6 percent money growth as sufficient for the agreed-upon growth goals, McCracken told Shultz as he affirmed $1064 billion that “I further propose that we do not



settle on an Administration view of the rate of monetary growth needed to achieve this path until we have discussed together the estimates available from a variety of sources.”13 CEA was concerned that the Laffer-Ranson model, in not requiring immodest growth in the money supply, could justify policy that was content to “rock along.” Indeed, the Laffer model noted that money growth of 8 percent was so unusual it was probably beyond its analytical capabilities. The difference in perspective came through in a series of memoranda CEA prepared for Ehrlichman in December for an upcoming meeting of Nixon’s with Federal Reserve chair Arthur F. Burns. “Most conventional forecasts for 1971 suggest a GNP of about $1050 billion,” as McCracken wrote to Ehrlichman. “In our view the objective for policy should be a course for the economy that would give a GNP of $15 or $20  billion higher, or 1,065-1070.” And as Ehrlichman quoted McCracken to Nixon, “The most fruitful issue to explore is whether Arthur and the Federal Reserve would accept our view about where the economy ought to go in 1971.” Ehrlichman continued to Nixon summarizing the CEA’s view: “The risks of expansive policy depend in part on public expectations” that come from poor signals from leadership. “We do not think that the risks include an inflation rate above our recent experience,” as Stein confirmed—a signal that the Federal Reserve should feel free to be loose. McCracken had written to Nixon in November, “Monetary policy will need to be more expansive than thus far in 1970,” which he estimated currently as achieving money-supply growth of 5.2 percent per year. “It is quite improbable that a 10 percent per year growth in GNP”—or 1070 in 1971—“can be achieved with such sluggish monetary expansion.”14 Late that December, McCracken assigned a member of his staff, William Silber (the future Paul Volcker biographer), to assess critically the Laffer-­ Ranson model. McCracken was probably interested in discrediting the model before Nixon might decide with Shultz for 6 percent over 8 percent money growth. The review McCracken solicited expressed surprise at Laffer’s methods. As Silber reported, “A curious result of Laffer’s model is that the current (same quarter) impact of money on GNP is large (3 or 4 times as great as other versions of St. Louis) and, furthermore, there are no lags in the effect of money on GNP.” McCracken already knew this— these contentions supported Shultz’s insistence on merely 6 percent money growth for 1971. Silber then gave McCracken some ammunition: “If there is one proposition on which economists of every persuasion (from Friedman to Samuelson) agree, it is that there are lags in the impact



of money on GNP. For this reason alone one must treat Laffer’s model with suspicion.” McCracken sent the Silber study to Shultz, with copies to the treasury secretary and Nixon’s assistant Peter Flanigan, and played naïve about it. In his cover letter he wrote, “I profess nothing beyond lay expertness myself in the mysteries of econometric analysis.”15 This was the first salvo in what turned out to be a cannonade of disparagement of the OMB model, the predominant part of which was to come the following February. The main point in the Silber-McCracken criticism was an odd one. The proposition that there were lags in money supply was manifestly that in the economics literature—a proposition. The ever-­ argumentative Friedman introduced the notion as such in the 1940s. The authors of the St. Louis model as of the previous May explicitly considered lags as a hypothesis requiring testing. There was, naturally, no settled science on the matter. In his “Trade Credit and the Money Market” paper of earlier in the year in the JPE, Laffer had vindicated the view that money is endogenously determined. If there was a shortage in bank money, trade credit arose at the moment to fill the gap. Money was a spontaneous creation of the marketplace—it did not arise from monetary policy, and its effect on output was immediate, in that it was coextensive with the productive process. Laffer’s point was expressive of a school of thought which necessarily arrayed itself against any arguments holding that money was exogenous and had effects typical to exogenous factors such as lags. Earlier contributions to this school of thought of Laffer’s included the “Anti-Traditional Theory” and the Madrid conference papers. In these, Laffer outlined how not merely the demand but the supply of money is endogenously determined. Under fixed exchange rates, if a national central bank is being too tight for the given domestic circumstances, money will flow in from abroad. The level of domestic demand for money determines the money supply. The behavior of the central bank does not. As Laffer wrote in “Trade Credit and the Money Market”: With very few exceptions the real money supply has been viewed as fixed in the short run, depending solely upon the whims of the monetary authorities. The money demand function has been considered to be a combination of stable relationships between real money demanded and other economic variables. Thus, the supply of money is exogenously determined and shifts over time, whereas the demand function for money is stable. The actual time series observations, therefore, supposedly map out the demand function for



money. Upon reconsideration, however, it should be obvious that the supply of money, especially when unutilized trade credit available is included, is not purely exogenously determined. Considering solely the supply of money, if the price of money were to rise—the difference between bank lending rates and deposit rates as well as trade credit—ceteris paribus, the quantity of money supplied should increase. Banks would want to reduce excess reserves and make additional loans at the greater margins. Similarly, firms would attempt to extend additional trade credit at the higher rates.

In another place in this paper, Laffer pointed out that trade credit had distinct similarities to the money-supply aggregates, such as demand deposits. Neither was wealth a “luxury good” (as Friedman and Schwartz had spoken of money in certain circumstances when it is socked away) but money available to affect economic transactions. Money, in Laffer’s analysis, became at the ready and in supply when there was demand for it.16 Though Laffer conceded that “with very few exceptions” it was generally held that monetary authorities define the money supply in the short term, his own footnotes suggested otherwise. One of them was to a Karl Brunner and Allan H.  Meltzer article in a 1964 issue of the Journal of Finance. This was an extensive mathematical examination of the elasticity of the money stock with respect to monetary policy. The authors did not come to final conclusions but entertained the possibility that there was a range of relationships, presumably involving timing, between the two terms. In the extreme cases, their measure either “approaches unity with consequent reduction toward zero of the elasticities of the money supply with respect to the policy variables,” or it “maintains the elasticities of the money supply with respect to the policy variables in their former neighborhood.” In between the two extremes was a world of possibilities of responses to monetary policy. Brunner and Meltzer would, in 1973, found the Shadow Open Market Committee (SOMC) whose purpose was to offer, in regular meetings, alternative monetary policy moves than the Fed was currently making. Characteristically, in the 1970s, Brunner and Meltzer’s SOMC contended that the Fed should be targeting lower money stock growth.17 Laffer’s 1970 JPE article also cited recent work by Ronald Teigen in Econometrica that explicitly sought “to segregate the exogenous and endogenous aspects of the money stock.” Teigen argued that to the considerable extent that banks have discretion in maintaining their reserves,



the money stock follows monetary demand. The implications for lags were significant. As Laffer had noted in the JPE, trade credit was equivalent to demand deposits in that both represented money at the ready to be used for economic transactions—necessarily affecting GNP. One further major entry in this tradition came in the May 1970 issue of the Quarterly Journal of Economics, seven months prior to the Silber critique, in which James Tobin questioned the Friedman lag theory in the name of Keynesian interpretations of the demand for money. Tobin did not dispute that theories of “timing” and “leads and lags at cyclical turning points” were common, but wondered at their wisdom. Of beliefs in “turning points in the rate of change of [the] money supply [showing] a long lead, and turning points in the money stock … a shorter lead, over turning points in money income,” he wrote: “A great deal of the popular and semiprofessional appeal of the modern quantity theory can be attributed to these often repeated facts. However, the relevance of timing evidence has been seriously questioned,” with a note offering citations.18 December 1970 turned out to be one of the last times it could be entertained that there was consensus about a major monetary-policy verity—including lags in the effect of monetary policy on economic output. The stagflation waiting in the wings would kill off all such consensus. The existence of the SOMC within two years would make the standard monetary-­policy arguments untenable on their face. The work of Fischer Black would all but squeeze the exogenous and lag theories out of the journals—and Friedman’s money workshop at Chicago. From a public-­ choice perspective, it is however understandable why lag theory in particular might have found a receptive audience among the members of the monetary-policy establishment. It got them off the hook. If the effect of monetary policy is not immediate and clear, if its lag effect is long and variable, policy cannot be quickly assessed as a success or failure. One has berth to try again and continue to have a claim on resources and attention. The Laffer-Ranson model did not exclude the possibility of lags—it tested for them explicitly. The GNP equations in the model gave the lags a chance to show their force; they ended up washing them out. Lagged values were part of the scatterplots, but their existence in those scatterplots made the regression lines less explicit and clear. This was of a piece with a hypothesis test. The originators of the St. Louis model put it this way in 1968: “In scientific methodology, testing a hypothesis consists of the statement of the hypothesis, deriving by means of logic testable consequences expected from it, and then taking observations from past



experience which show the presence or absence of the expected consequences. If the expected consequences do not occur, then the hypothesis is said to be ‘not confirmed’ by the evidence.” In the Laffer-Ranson model, the numbers came in “not confirmed” in the case of monetary lags. The inputs corresponding to monetary lags failed to fit dependentvariable values, above all GNP.  The core of Keynesianism, government spending, met the same fate—it tested not confirmed by the pattern of post-World War II macroeconomic outcomes.19

Going Public The Economic Report of the President came in early February with substantial doses of CEA language about “feasible” and “paths.” As a section began, “The goals for the performance of the economy in 1971 are clear. Our objectives should be to move along a path through 1971 that will bring the unemployment rate in 1972 down to the zone of reasonably full employment, and at the same time to get the rate of inflation down to the 3-percent range.” As it went on in this vein, the Report arrived at this passage: “There is a considerable body of opinion that expects the gross national product for 1971 to be in the range between $1045 billion and $1050 billion, which would be an increase of 7 to 7½ percent above that for 1970. This is a possible outcome. However, it seems more likely that with present policies the outcome would be higher than that and could be as high as $1065 billion. A $1065 billion GNP for 1971 would be consistent with satisfactory progress towards the feasible targets suggested above.” It was now public that the administration envisioned about 9 percent nominal GNP growth for 1971 after the recession year of 1970.20 The budget released several days earlier had used the same number, $1065  billion for 1971 GNP.  In transmitting the budget to Congress, Nixon noted that it “accepts the principle that budget policy, together with monetary policy and the active cooperation of the private sector, must be used to help achieve full employment in peacetime with relative price stability.” Nixon had treated similar themes in his State of the Union address of the week before. In that address, he said that the nation had to “achieve what Americans have not enjoyed since 1957—full prosperity in peacetime.” He warned, however, that “as we have been moving from a wartime economy to a peacetime economy, we have paid a price in increased unemployment …. We must do better for workers in peacetime and we will do better.”



Nixon well knew, from his experience as vice-president, that 1957 was a year in which an exceptionally sharp recession began. This was the recession of 1957–58, which had a two-quarterly drop in economic output, of 7 percent per annum, comparable in severity to that of the 2008–09 turn. The sluggishness imposed by that recession, Nixon surely contemplated, was a major factor in denying him victory in the presidential election against John F. Kennedy in 1960. An economy for the long term in peace that lacked legions of unemployed and was not cursed with a frequency of recessions—these conditions were actually hard to discern since not merely World War II but World War I. Policy would have to try to procure them, if it could, in the 1970s. The specific context in which supply-side economics arose was that in which the United States contemplated if it was even possible for a modern economy to grow absent the purported stimulants and compensations of warfare. Among the conclusions Laffer and Ranson made on running the post-World War II data through their model was that the spur to growth comes neither from the Federal Reserve—nor in any lasting way from government spending. These views, particularly concerning government spending, were perhaps fearsome to contemplate at that point in time. At the beginning of the 1970s, it was challenging to envision how there might be economic growth and high levels of employment upcoming in the United States. The reason was the Vietnam war. It was at last winding down. Military personnel on active duty had peaked at over 3.5 million in 1968 and was declining rapidly, to be as low as 2.3 million in 1972. Officials had structured the draft so as to disturb the American labor markets as little as possible and, where conceivable, enhance them. Young men with distinctive productive prospects—who were in college and graduate school—were generally exempt, while those starting out on a less-productive career path in the working class were fully eligible. Moreover, there were special programs such as secretary of defense Robert “McNamara’s 100,000” that enlisted into the services recruits whose scores were too low to gain acceptance into the military even if drafted. The plan was to build up the labor-­ force quality of these young men through military experience tailored to the purpose. The national unemployment rate of 3.4 percent in late 1968 and early 1969 was at its lowest level since the demobilization from the Korean war of the early 1950s, and the economic-growth rate since the early 1960s was averaging about 5 percent per year. The care to respect labor productivities that had gone into the conception of the draft had



proven consistent with mopping up unemployment and a distinct economic expansion. From a sociological perspective, Vietnam had also helped to clear out the secondary effects of unemployment, specifically youth unemployment. The “juvenile delinquency” problem of the 1950s and early 1960s correlated with unemployment rates of often around 7 percent, for youth at least double that figure. As social-justice activist Michael Harrington had pointed out in The Other America: Poverty in the United States (1962), not starting out or barely having a job as a young person often presaged a lifetime of being on the margins of employment. As went minority unemployment, the “last hired and first fired” trap was particularly problematic in a period, such as 1949–60, when the fully four recessions in those eleven years occurred every 24–45 months. In such conditions, the last hired and first fired were barely ever hired at all. Vietnam perfected Keynesian verities where even World War II had not. The draft in World War II was comprehensive and willy-nilly, and people enlisted anyway. Vietnam, in comparison, corresponded to the preciseness of the liquidity trap. Per the General Theory (1936), given the many large fortunes of the era of late capitalism, markets clear below full employment. The rich had become too numerous and too moneyed to even care about investing for return anymore. The paucity even of the spirit to invest, a result of the piling up of fortunes after years of the industrial revolution, was to the Keynesian interpretation the mechanism of the liquidity trap. The social consequence was considerable unemployment. Not everybody is unemployed in these conditions—just a healthy some. In Vietnam policy, those who were able in the Keynesian liquidity-trap world that was the American economy of the postwar era to find and keep work were left unmolested. The liquidity-trap residual of non-college material and skill-­ less youth were the targets of the draft and the likes of McNamara’s 100,000. The Keynesian scalpel carved out draft policy in the Vietnam era. As for those who got ensnared in the service, they would get some pay and supplies (augmenting aggregate demand), they would perhaps build up some skills useful afterwards in the civilian labor market (moderating the liquidity trap), and some of them would get killed off (lightening the residual). Before the American Economic Association in 1971, Joan Robinson said: I do not think it plausible to suppose that the cold war and several hot wars were invented just to solve the employment problem. But certainly they



have had that effect. The system had the support … of the economists who advocated government loan-expenditure as a prophylactic against stagnation. Whatever were the deeper forces leading into the hypertrophy of military power after [World War II] was over, certainly they could not have had such free play if the doctrine of sound finance had still been respected. It was the so-called Keynesians who persuaded successive presidents that there is no harm in a budget deficit and left the military-industrial complex to take advantage of it. So it has come about that Keynes’ pleasant daydream was turned into a nightmare of terror …. The whole trouble arises from just one simple omission: when Keynes became orthodox they forgot to change the question and ask what employment should be for.

James Tobin, defending the New Economics of the 1960s, found Robinson’s remarks “ridiculous.”21 An uncharitable and loathsome portrait, perhaps, is all this—but without entertaining the potential reach and contours of the Keynesian psychology at the apex of the Keynesian era, the postwar period, historical understanding runs the risk of missing fundamental dynamics in the operation of American economic policy at this time. Laffer’s positioning within the policy establishment at the waning of the Vietnam debacle-cum-­ outrage is instructive. He was at OMB at its founding. To the federal peacetime budget had devolved the great burden of Keynesian economic therapy, after the exhaustion of Vietnam. The Laffer-Ranson work indicated the high importance, at that historical juncture, that the authors felt attached to the development of an economic model that yielded growth and employment not by means of a government response to the liquidity trap—but by means of peacetime productivities. Their OMB model was not that—it was more passive, a hypothesis-testing model. But it suggested that a new simulation-style model showing how markets can clear, how productivities can be fully engaged in an economy by their own devices was in order. The Vietnam problem put a fine point on why it was timely to be an antithesis of Keynesianism, a “modern Say.” The matter of growing thanks to endogenous forces, which in increasingly obvious fashion was becoming the missing element in Laffer’s academic work, was taking on a special significance in the 1970s with the waning of that quintessence of exogenous economic inputs, warfare.



Notes 1. Eugene F.  Fama, “Efficient Capital Markets: A Review of Theory and Empirical Work,” Journal of Finance 25, no. 2 (May 1970), 383. 2. Arthur B. Laffer and R. David Ranson, “A Formal Model of the Economy,” Journal of Business 44, no. 3 (July 1971), 247, 251. See early versions of the model in the Herbert Stein and Paul McCracken papers at the RNPL. 3. Laffer and Ranson, “A Formal Model of the Economy,” 262. 4. Laffer and Ranson, “A Formal Model of the Economy,” 256–57. 5. Leonall C.  Andersen and Keith M.  Carlson, “A Monetarist Model for Economic Stabilization,” Federal Reserve Bank of St. Louis Review 52, no. 4 (April 1970), 21. 6. Laffer and Ranson, “A Formal Model of the Economy,” 247, 248, 256. 7. George P. Shultz, “Strategies for National Labor Policy,” Journal of Law & Economics 6 (Oct. 1963), 2. 8. Allen J.  Matusow, Nixon’s Economy: Booms, Busts, Dollars, and Votes (Lawrence: University Press of Kansas, 1998), 76–77. 9. Economic Report of the President (GPO, 1970), 3, 57. 10. Matusow, Nixon’s Economy, 89. 11. Memorandum, Frank Ripley and Murray Foss to Herbert Stein, June 26, 1970, “Presidential Meetings—Troika 1” folder, “Presidential Meetings” file, WHCF: SMOF Paul W.  McCracken papers, RNPL [hereafter, “McCracken papers”]. 12. Memoranda, McCracken to Nixon, June 13 and August 23, 1970, “Memos for the President,” June and August 1970 folders, “Memos for the President” file, McCracken papers. 13. Memorandum, McCracken to Kennedy and Shultz, Dec. 17, 1970, “Shultz, George 1” folder, “White House Staff Memos” file, McCracken papers. 14. Matusow, Nixon’s Economy, 89; memoranda, McCracken to Ehrlichman, Dec. 11, 1970; Ehrlichman to Nixon, “Meeting with Dr. Arthur Burns,” Dec. 14, 1970; Stein, “Notes for Discussion with AFB,” Dec. 11, 1970; McCracken to Nixon, Nov. 16, 1970, WHCF Subject Categories: EX FG 131, 7/1/70–12/31/70, RNPL. 15. William Silber to McCracken, “Models for explaining GNP, etc. …,” Dec. 29, 1970, and McCracken to Shultz, Dec. 31, 1970, “Shultz, George 1” folder, “White House Staff Memos” file, McCracken papers. 16. Laffer, “Trade Credit and the Money Market,” 251–52, 259. 17. Karl Brunner and Allan H.  Meltzer, “Some Further Investigations of Demand and Supply Functions for Money,” Journal of Finance 19, no. 2, part 1 (May 1964), 279.



18. Ronald L.  Teigen, “Demand and Supply Functions for Money in the United States: Some Structural Estimates,” Econometrica 32, no. 4 (Oct. 1964), 476; James Tobin, “Money and Income: Post Hoc Ergo Propter Hoc?” QJE 84, no. 2 (May 1970), 302. 19. Leonall C. Andersen and Jerry L. Jordan, “Monetary and Fiscal Actions: A Test of Their Relative Importance in Economic Stabilization,” Federal Reserve Bank of St. Louis Review 50, no. 11 (November 1968), 15. 20. Economic Report of the President (GPO, 1971), 75, 84. 21. Joan Robinson, “The Second Crisis of Economic Theory,” AER 62, no. 1/2 (March 1972), 6–8; Tobin, The New Economics One Decade Older, 50.



The administration’s release of the Budget of the United States Government and the Economic Report of the President, in late January and early February 1971, occasioned quizzicality among the Washington press corps, and soon enough members of Congress, concerning the GNP projection for the current calendar year. This was the $1065 billion number settled on by CEA in the fall as the optimum feasible path, downgraded from $1070.5 billion after the General Motors strike. Given that it appeared that 1970 GNP was coming in at about 978 billion, “1065”—enunciated as “ten sixty-five” across Washington, DC circles as of early February—nominal GNP growth according to the president’s planners would be 9 percent in the year after the recession. The number was high. Business and academic forecasters were generally in accord that 1971 GNP would be on the order of 1045–1050. The number coming from Nixon’s agencies was a “glowing forecast,” and “unexpectedly ebullient,” as well as “more bullish” and a projection of a “record gain,” as the Wall Street Journal put it on reporting the news. 1065 “outstrips private views”, added the Journal, and was “far above most private forecasts,” to the Washington Post, both papers indicating that such forecasts clustered in the 1045–1050 range. “Strong Economic Gain Predicted,” ran a New York Times headline accompanying a picture of Nixon’s signing the administration’s budget. The gist of the accompanying commentary was that Nixon was hoping beyond hope for an © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 B. Domitrovic, The Emergence of Arthur Laffer, Archival Insights into the Evolution of Economics,




uncommonly strong recovery the year before the 1972 presidential election.1 A column by Leonard Silk in the New York Times added an element of intrigue to the story. In the February 3, 1971, issue of the newspaper, Silk proposed that there was  a “great mystery” concerning “the Nixon Administration’s budget for fiscal 1972 and…the Economic Report of the President,” released successively over the previous several days. This was “how the Council of Economic Advisers arrived at a gross national product forecast of $1065-billion for 1971—$15 to $20-billion higher than that predicted by most private economists, including some who have been close to the Administration,” such as forecaster Alan Greenspan. Silk wrote that “according to one insider, the CEA had intended to show a GNP forecast of about $1052-billion when the White House decided this was just too low and therefore ‘unacceptable’ to the President.” He added that the “President’s economists had been only a little above the private ‘standard forecast’ range of $1045 to $1050-billion until less than 24 hours before the Budget document was closed for final printing.” Regarding the CEA members, Silk wrote that “McCracken and his colleagues…are men who pride themselves on their personal and professional integrity, which they mean to safeguard.” But “they are far from the first Council of Economic Advisers to be caught in a forecasting and policy-­ counseling squeeze because the White House did not like the politics of what the  economists were saying.” Silk offered this analysis: the CEA “economists are seeking to justify their willingness to specify the very high $1065 billion…as a target required of them by the Employment Act of 1946. The McCracken Council has rolled the policy target and the economic forecast into the same number, while noting that the actual GNP this year might turn out to be as low as the private economists say.”2 Perhaps the key phrase in Silk’s extended column—distinguished within the Times news pages as being an “Economic Analysis”—was “according to one insider.” The documentary record dating back to the previous June showed continually that CEA both devised the optimum feasible path and proposed that the administration put forward the optimum number as opposed to a base forecast. McCracken himself was clear about this in November and December, noting that his CEA would be the first to fulfill (compared to Silk’s “required”) the Employment Act of 1946 and give the optimum number, while proposing to Shultz that 1064 be that number, with the money-supply details settled later. If Silk was not privy to these documents, he had access to their equivalents in conversation by

6 1065 


virtue of his status as the New York Times paper-of-record journalist on this particular beat. It is difficult to see how a plurality of “observers” relevant to the CEA in the second half of 1970 would have testified to anything other than McCracken’s insistence on putting forward a number on or about 1065. In citing “one observer,” Silk indicated that his column did not aspire to preliminary credibility, in that it explicitly lacked multiple sources. Other news and opinion outlets took up the story. Hobart Rowen of the Washington Post reported differently from Silk. As his headline the next day ran, “Record GNP Figure Came from Council: CEA Differs with Shultz over Money Supply Needs.” The headline communicated the essential facts that are now clear from the archival record from across the latter half of 1970—suggesting that Rowen had called on a range of sources on this issue as would be expected for a Post reporter in this area. Rowen wrote that 1065 “produced a great deal of astonishment this week among observers who think the President has set too high [a] goal in his anxiety to promote recovery from recession. But it also produced some questionable press reports on the origin of the $1065 billion figure.” Rowen noted that various outlets including the New York Times “have suggested in one way or another that the big number came from Office of Management and Budget and…was resisted by the Council of Economic Advisers.” But “this is not correct, a careful check with responsible authorities throughout the Government shows.” Rowen went on to discuss how the disagreement between CEA and OMB concerned not 1065 but the way to get there via monetary policy, that CEA had been using the number or higher ones since the summer, and that the lower number Silk had offered as the CEA’s was that which CEA had been ridiculing as the result that would come with unpreferable “rock along” policy. Rowen mentioned one further detail. This was that “OMB (with Arthur Laffer, a young economist-assistant to George Shultz, doing the analysis) was willing to go to $1070 billion.”3 Members of Congress discussed the issue, largely incredulously, with McCracken, in testimony accompanying the submission of the Economic Report of the President to the Joint Economic Committee of the House and Senate. The next week, Shultz testified. In his remarks, he made an allusion not captured in the hearing transcript, and clarified after the session in interviews with reporters, that OMB approval of 1065 came after the agency ran the figure through its Laffer-Ranson model. Silk responded with a long and palpably careful article the next day. It was partially



consistent with his article of the week before, beginning with the phrase, “for a complete explanation of the mystery of how the Nixon Administration arrived at the bullish forecast” of 1065, “you have to go to the Office of Management and Budget…and [the] agency’s econometric model.”4 This article went on to detail the Laffer-Ranson model, summarizing it ably. The authors “did not set out to build their model on the basis of any single theory,” as Silk wrote. “It contains three basic constructs: The modern Quantity Theory of Money, as advanced by Prof. Milton Friedman; the Keynesian fiscalist theory, which depends primarily upon changes in Federal spending on goods and services; and the theory of ‘efficient markets,’ which holds that at any given time market-prices reflect the best currently available information.” Silk noted that the model’s authors dispensed with seasonally adjusted data on the grounds that such sources “resulted in distorted and misleading forecasts.” He observed that “their most striking result was that finding that changes in the money supply had an ‘instantaneous and permanent’ effect on GNP, rather than a lagged effect.” And he explained that “the best measure of the impact of fiscal policy, they concluded, is Federal spending on goods and services, rather than changes in the over-all budget.” Silk expounded the “technical jargon” behind the stakes in the model. “The skeptics regard money supply changes as ‘endogenous,’ or within the system. But most economists would agree with Profs. Laffer and Ranson that the Federal Reserve largely determines the rate of growth of the money supply, and that it is therefore ‘exogenous’—outside the system.” Silk’s article got that last point wrong—Laffer and Ranson defended endogeneity—and it may have borne the sting of Rowen’s criticism of the previous week. It was detailed and respectful of the OMB model, and it did not push the argument that the model yielded or produced the high 1065 figure against the objections of the CEA. Rather, it concurred, effectively, with Rowen, that the disagreement was not about the GNP number but the monetary policy required to procure it. “McCracken of the CEA has called for a monetary growth rate of 6 to 9 percent, to get GNP up to $1065-billion this year. But OMB thinks anything above 6 percent is excessive.” Silk’s explanation of the competing endogenous-exogenous concepts gave the theoretical background of the CEA-OMB difference of opinion, even if that explanation misidentified Laffer as a vindicator of exogeneity. Silk fell into muddle in one line of the article. He wrote, “their model contains only four equations to predict money GNP, real GNP, inflation

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and unemployment.” Silk misunderstood that these “four” macroeconomic outcomes were each a dependent variable. By definition, a dependent variable can “only” have one equation. If there are multiple equations and one unknown, the algebra is not finished. The equations must be combined and reduced to one equation. This misunderstanding may have fed, in part, the coming controversy over the model. In the inordinate talk about the model that emerged over the next several weeks, the point that the Laffer-Ranson model was simplistic and suffered from a paucity of variables owed in some part to the conflation, on the part of the critics, of dependent and independent variables. The Laffer-Ranson model had about two dozen independent variables and could accommodate more. It had as many equations as there were macroeconomic outcomes in question, one for each. Nominal GNP was one outcome. It could have one and only one equation. This equation expressed the outcome via independent variables, all of which were known quantities given by the data. They appeared in all their variety in the scatterplot but remained in the equation on the basis of how well they produced a regression line.

Samuelson on Tape If the discussion of 1065 took a recondite turn with Silk’s chastened and workmanlike column after the Rowen criticism, it represented a calm before the storm. Talk of “Laffer’s money machine” was circulating in Washington, as Rowen reported, and other columnists proved not so concerned as Silk to back away from mocking the model. This original spate of criticism of the model received a remarkable assist in the form of an audiotape mailed out to untold numbers of subscribers, probably numbering in the several thousands, in the business, financial, and policy worlds, on the part of the company Instructional Dynamics, Inc. This company made recorded interviews with top economists—what decades later would be called a podcast—and provided them through the mail in cassette-tape form several times a month across a subscription base that penetrated major spheres of American professional and political life.5 The February 19 edition was an interview with Paul Samuelson, the Massachusetts Institute of Technology economics heavyweight who two months earlier in Stockholm had received the Nobel Prize in economics. The title of the cassette was “Why They Are Laughing at Laffer.” It lasted thirty minutes and was a spectacle of invective and facetiousness at Laffer’s expense, all concerning 1065.6



At the outset, Samuelson reminded his listeners that in his previous tape of two weeks before, he had gone over the “comic-opera” atmosphere and “melodrama” surrounding the White House economic forecasts. This was a foretaste of the demeaning language Samuelson would use throughout the thirty minutes with respect to his topic. His terms included “lo and behold” (twice) to refer to the moment 1065 emerged from the model, “providence” having brought forth the “glad tidings” of 1065 from “on high,” 1065 was “idiocy” and a “put-on,” Laffer was a “neophyte” and “Shultz’s boy,” the model was of the “Santa Claus” variety and reflected a “dreamworld,” and the Nixon forecasting process was “comical.” Discussing the need to dispense with the model, Samuelson recounted Sigmund Freud on the improvement in one’s ability to do sophisticated analysis after one is “toilet trained.” Such a tone was not entirely out-of-place for Samuelson. The subscribers to this series, which had been going on since 1968, would have heard some similar language, and certainly perceived the copping of an attitude on Samuelson’s part, in previous tapes. But the sarcasm in the “Why They Are Laughing at Laffer” tape may have been unique. The substance of Samuelson’s remarks had a questionable premise. Samuelson said, “In my last tape” (of February 5), “I discussed some of the comic-opera aspects of these [Nixon] forecasts….Is the New York Times reporter correct, Leonard Silk, that a last-minute telephone call went from the White House to the technicians and” the CEA “saying that your numbers of, let us say,” 1052 “are unacceptable,” that they “must be increased for high reasons of state—or was there no resistance by the Council of Economic Advisers and did that represent their best forecast?” He then went on to Shultz’s testimony of the next week. Silk did in fact report the events as Samuelson recounted them—in his column of February 3. But in his column of a week later, Silk clarified what he had written in the previous column, knocked as it had been by Rowen at the Post for not being fully sourced and getting details wrong. Silk’s February 10 column was a correction of and more extensively sourced update on the topic Silk had introduced on February 3. In his tape made on February 19, Samuelson recounted the Silk of February 3 with no mention of the subsequent clarifications. Samuelson chose to refer to what he had said “in my last tape” (of February 5). This was asking “is the New York Times reporter correct” without indicating that in the meantime, a number of those who had looked into the matter, including the New York Times reporter himself, had found that that

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reporter was not correct. Moreover, the alternatives Samuelson offered on February 5, and repeated on the 19th, were whether the White House had forced the CEA to accept a higher number at the last minute, or “was there no resistance” from the CEA since 1065 did “represent their best forecast.” The “was there no resistance” was an interesting turn of phrase. Technically, perhaps, it could encompass the CEA on its own devising 1065–1071 since June 1970 and pushing it on the administration, which is largely what happened. The Baltimore Orioles had offered “no resistance” to winning the World Series the previous October—a linguist might not find technical fault with this sort of phrasing. But idiomatically, such language is at the edge of being misleading. To say that in general, and especially in his public commentaries, Samuelson did not toy with—did not cultivate the arts of—prevarication courts understatement. His classic textbook, Economics, offers examples. The 1958 edition’s Chapter 12 on Keynesianism provides in its first paragraph a textbook case of a false dilemma: “Whether we are to face a situation of inflationary bidding up of prices or shall live in a frigid state of mass unemployment depends, as we shall see, upon the level of investment.” The inflation-unemployment trade-off, the “Phillips curve,” as it was soon to become known, was a proposition subject to falsifiability like all other propositions. Therefore, it should have been presented as a testable dilemma in the textbook. Samuelson’s use of turns of phrase (“bidding up”) and adjectives (“frigid”) played syntactical roles in couching the fallacy idiomatically, in warming the reader to it. Later in the chapter in discussing the paradox of thrift, Samuelson wrote, without distinguishing if he was representing a view not his own, “through proper national policies, we must recreate a high-employment environment in which private virtues are no longer social follies.” Are private virtues social follies? The “no longer” functions as an instrument of manipulation.7 Samuelson was practiced at cultivating misapprehensions in the reader’s mind while retaining a sense of plausible deniability that he was doing anything untoward. The “Why They Are Laughing at Laffer” tape had the method in the title. Were they laughing at Laffer? The “why” served as a tool of presumption, prompting the listener to assume as much, or in an uncareful moment to be defensive about the contrary position—which would have been unnecessary, since it was Samuelson who was trading in prevarication. Who were “they”? Were Silk and Rowen part of them? The former had better have been, in that his initial column was the premise of the whole Samuelson discourse. Yet Silk had all but retracted that column.



Samuelson had his Wall Street audience via Instructional Dynamics, and that audience full of mature people who could handle themselves perhaps was prepared to indulge him in his quirks. There is a chance that these people listening were laughing at him, the academic. On the tape, Samuelson kept at it. He said that there was a “new element” beyond the original Silk story and the attention it had brought, namely Shultz’s testimony that revealed a “little model” developed at OMB care of Laffer that had justified 1065. Here Samuelson strayed from the chastened carefulness of Silk’s second column in describing the OMB model and its relationship to 1065. Samuelson said, “I do have his basic equation for money GNP change. This is the heart of his model. This is the equation, from which by itself, the 1.065 trillion estimate of the administration can be derived. Let me read to you what the equation consists of.” He noted, skeptically, that it used seasonally unadjusted data and had several constants, the unlagged change in the money supply, changes in government expenditures, a strike variable, and “a little kick from the stock market.” The word “derived” was questionable usage on Samuelson’s part. Perhaps Samuelson only had Laffer’s nominal GNP equation and not the full model—which had received extensive treatment in the press including from Silk. The Laffer-Ranson model did not derive the dependent variable. It assessed what independent variables, if any, fell within a reasonable range of a given dependent variable (1065 given, in this case, from CEA’s “optimum feasible path”). It ran regressions of the independent variables and threw out those values in the scatterplot that did not fit the line well within a standard deviation of the dependent variable. It was an ex post model. The dependent variable was not to be derived and had to be given. The data used in the construction of the model were official and previously published. An ex ante model would yield a previously unknown result on the basis of inputs. Samuelson spent some time describing these kinds of “component” GNP models while implying, with the “derived,” that Laffer’s model belonged in that category. When he mentioned the “little kick from the stock market,” he gave the game away. A kick can come in an ex ante but not an ex post model. In the latter type, even if there is a chronologically leading variable, as in the stock market case in the Laffer-Ranson model, a variable is either within a reasonable range of an already named outcome or it is not. In the former type, a variable can produce an as yet unnamed outcome. Samuelson was conflating, was mangling, the matter before him. It is not warranted to presume that Samuelson

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was not aware of this, given his extensive record of employing confusing verbal tactics. Samuelson compared the Laffer-Ranson model unfavorably to the St. Louis model. He said that “if somebody had told me about this in a hypothetical way, I’d say it was a put-on, that the whole purpose of this exercise is to discredit monetarism….and that some nefarious person who wasn’t able to undermine the Federal Reserve Bank of St. Louis model, let’s say by honest, legitimate criticism, and thinks he’ll do it just by humor and indirection would create this model.” On five or so occasions on the tape, Samuelson referred to Laffer’s “little model.” The “little” presumably referred to the number and variety of independent variables. The St. Louis model, as its point of pride, had for its GNP equations all of two independent variables, the change in the money stock and in federal spending, expanded to include various lagged values. Laffer’s model was “little” if compared to the ex ante models meant to provide component GNP information. It was at least as large as the St. Louis model. This is not to recount the uses to which Samuelson put all the acid language, the “toilet trained” and so forth, language which set the tone of the thirty minutes on tape. He returned to his subject of the CEA, noting as he had in his previous tape that 1065 did not represent any kind of “mean” or “modal” number or an “estimate of central tendency.” He did not, however, indicate why 1065 had to be that number. Rather, he said that it need not be a most likely “central tendency” finding. He said there could be “high reasons of state,” which he admirably conceded could be legitimate, for the CEA to propose a number above that of the central tendency. This is, in fact, what McCracken and Stein had been arguing for since the previous June. CEA should propose a number representing an optimum feasible path well above the central tendency. Moreover, McCracken noted, this was CEA’s statutory responsibility. The Nixon archives, furthermore, show how the original 1070.5 was “derived” ex ante in the summer of 1970 by component analysis from CEA staff— “technicians.” They assumed strong lagged-effect money growth, major new housing appropriations, a full-employment balanced budget, and other factors. Perhaps these details were not at the ready to readers of newspapers and scholarly articles, but Samuelson had the opportunity to see Silk’s revisions before he made his February 19 remarks. In the tape, the recent news analysis to which Samuelson referred was a syndicated column that came out after Silk’s second article. This was a profile of Laffer called, a



“Whiz Kid Who’s ‘Not Afraid’” by Joseph R. Slevin. This column began, “President Nixon is betting all of his economic policy chips…on a new kind of forecast by a young economist who had never put one together before. Arthur B. Laffer, the architect of Nixon’s controversial $1.065 trillion prediction….is chief economist of the [OMB,] and OMB director George Shultz relied on Laffer’s arithmetic in winning Administration adoption of the high $1.065 trillion target.” Slevin wrote that “Shultz nailed the Administration’s flag to the youthful Laffer’s $1.065 trillion prediction against the advice of the veteran economic teams of the Treasury and the Council of Economic Advisers.” As for the model itself, in Slevin’s words, it “is much simpler than most econometric models. It has only four equations instead of the hundreds and thousands that other econometricians use.”8 Samuelson said he had read the column in a Boston newspaper. It was manifestly superficial and uninformed in comparison to the Rowen-Silk back-and-forth in the newspapers of record. That Laffer was the “architect” of 1065 was inconsistent with the mass of evidence of physical memoranda emanating from the CEA since the previous June of which the beat reporters would have been aware. As for “nailed…against the advice,” McCracken had made clear to Shultz in December that he wanted 1064, arising as it had from CEA, as the nominal 1971 GNP number settled at that point, with the question left open of how to get there via monetary policy. The “only four equations” was repetition of the category mistake about dependent variables. Dependent variables can have one equation each, and Laffer made his dependent variables the four choice macroeconomic outcomes. There are not many major macroeconomic outcomes. Beyond nominal and real GNP and inflation and unemployment, there is little left, and what remains is distinctly secondary—the labor-force participation rate was a faddish statistic in the 2010s. If the question is of one particular outcome, nominal GNP as in the 1065 controversy, there will be exactly one equation regarding it. The St. Louis model, naturally, had one equation for change in nominal GNP. It was “delta” Y equals the sum of lagged changes in the money supply plus lagged changes in government expenditures times coefficients. Samuelson’s source base, therefore, for “Why They Are Laughing at Laffer,” was a selection from the bottom tier of coverage of the 1065 episode. It relied upon the first Silk column and the Slevin syndicated piece. The former was the subject of extensive revision and clarification, occasioned by inside reporting by Rowen. The Slevin piece came out after the

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Silk revision and a number of further pieces by Rowen but told the story as it had first been aired in rumor. Samuelson had a high opinion of Slevin. As he said in the tape, “Joseph Slevin, who is a very astute Washington correspondent, financial correspondent, who himself I believe writes one of the best inside government bond newsletters, and who has been known time and again for his pipeline for inside scoops in Washington, gave an interview” with Laffer. This was true. Slevin had interviewed Laffer. This meant that aside from the maturation of the 1065 story over the week before his column appeared, Slevin had the additional primary source of Laffer’s exclusive comments. His column, however, made a mess of the facts, and this rendered its interpretations invalid. The prehistory of 1065, as apprehensible through the range of sources available to the historian, might be summarized as follows. With the recession lingering when the May 1970 social disturbances hit, the leadership of the CEA decided that the administration had to get more ambitious in its economic goals and more dedicated to policy innovation that could achieve such goals. McCracken and Stein postulated that there could be an “optimum feasible path”—their coinage—of distinct and largely real GNP growth that would entail a rapid reduction in the unemployment rate. Of all feasible paths, it was the best one. These members of the CEA assigned their staff, the “technicians,” to determine if there was such a path and, if so, what would be the quarterly GNP figures and the unemployment rate through 1972. In June 1970, the staff reported. Via ex ante analysis, it was possible to see an optimum feasible path in which GNP in 1971 was 1070.5 with unemployment dropping to around 4 percent in 1972. Components required for this outcome included money-supply growth of 8 percent and federal housing spending. As early as July 1970, McCracken began to urge Nixon to adopt the optimum feasible path and seek policy to achieve it. He contrasted the optimum feasible path with “base” forecasts—the “central tendency,” perhaps—that would be consistent with current, “rock along” policy. He consistently urged money-supply growth of 8 percent. In August, CEA ran its path through the St. Louis model—which vindicated lagged output effects of money-supply growth—and confirmed that 8 percent was necessary for the path. After the General Motors strike led to lower latter-1970 GNP, CEA revised downward the optimum feasible path GNP number for 1971 to 1064. In November and December, McCracken insisted on using the path number, as opposed to the base forecast, in the Economic Report of the President on the grounds that the statute required aspirational goals.



He asked Shultz to accept 1064 and to continue to discuss with him the degree of money-supply growth needed to achieve it. A relatively minor detail late in this history was OMB’s running 1064 (or 1065) through its new model in December and saying the number was achievable. Evidence of controversy apprehensible in the archival record comes in correspondence of Laffer’s from January 1971. Laffer was proofreading the Economic Report of the President and saw that CEA was backing away from 1065. Laffer wrote to Shultz on January 22: The most important problem in this chapter is the refusal on the part of the authors to go along with the forecast of $1065 GNP…. The most important point…is that they do go along with  the $1065 GNP and the implications therefrom. The idea that GNP will, under current trends, result in $1045-$1060 GNP is wholly unacceptable. Not only is it unacceptable from the standpoint of this Administration, but it is also unacceptable from the standpoint of reasonable forecasting. I don’t think it is the job of the Council to say that our policies will lead us into a further quagmire of economic difficulties. Nor do I believe that these policies will lead us into this quagmire.

Archival copies of CEA’s early final typescript drafts of its Report may show that it posted a number well lower than 1065. However, this would have been at variance with McCracken’s offer to Shultz of December 17 to agree to 1064 while leaving money growth up for discussion. McCracken lost that argument with Nixon, who sided with Shultz on only 6 percent money growth. CEA may have then backed out of its own 1064/5 estimate because it had never made it without the assumption of less than 8 percent money growth. Yet McCracken had agreed to 1064 in any money scenario the month before the report was printed.9 Perhaps the February discussions would have been more accurate if it had been noted that CEA had always championed 1065 but tried to rescind the number when it had to compromise on monetary policy—having said that it would not rescind if it had to accept such a compromise. One thing was clear. Laffer was confident about his and Ranson’s model. The January correspondence indicated it, as did his use of the Bertrand Russell quotation, which he repeated to Shultz in early February. In the Slevin column, Laffer said, “I’ve never done an econometric model before but I’ll match this against anything else….I feel very safe. I’m not afraid of any of the other models.” The big difference in “A Formal Model of the

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Economy” was its vindication of the endogeneity of the money supply, the reason it saw 1065 out of 6 percent instead of 8 percent money growth. The money supply as a market given was a central theme in the top-shelf scholarly articles Laffer had been recently publishing. This was the basis of his confidence in the model. The CEA members endeavored to explain things when the talk on 1065 boomed after the budget and the Report were released. Stein most of all strove to claim 1065 as “uniquely ‘the Council’s number,’” while McCracken was harder to pin down. McCracken’s heart did not appear to be in 1065 if he had to accept less than 8 percent money growth. He had a number of testimony tangles with Sen. William Proxmire of Wisconsin, who wanted the component analysis from CEA staff to show him how 1065 could be built from scratch. Laffer’s name got attached to 1065, including as the butt of a jokes as discussion of the topic intensified and then simmered down over February and March. In May, the New York Times ran a cartoon depicting “Laffer’s Money Machine,” a mechanized clown head with its tongue sticking out. The tongue had “GNP” written on it, and underneath were men in suits kneeling in prayer. Accompanying the cartoon was a poem by “Alfred Priori,” probably a play on the formal logic term of a priori. To reason about something before it unfolds is to do so a priori, as opposed to reasoning afterward, a posteriori. It must have been a crack at Laffer’s ex post model being used for forecasting. Mr. A. Priori spoke of the model’s “four simple equations,” which in emphasizing simplicity over number was technically more precise than Slevin’s implicit demand for multiple equations for one unknown. Still, “such a quaint econometric model has seldom been seen,” 1065 “is more than a game,” and for all this fun, “the stakes are so high.” The poem closed: If the results are way off, then a year from this fall Down will come Nixon, Shultz, Laffer and all!10

The Ph.D. Fiasco The first reports of 1971 GNP would come in the 1045–1050 range, well below 1065. After five years of revisions incorporating new information, in 1976, that number was neared at 1063.4. Today, the United States reports 1971 GNP as 1172, on the basis of both new information and accounting changes. Economist Paul Krugman wrote in 1994:



Some years later, revised figures for 1971 places the dollar value of national output quite close to Laffer’s old forecast, something Laffer’s defenders have claimed as a vindication. But it isn’t. What Laffer was trying to forecast was not the dollar value of output but its growth rate; the revisions that raised the estimate for 1971 also raised the number for 1970, leaving Laffer’s growth forecast as far off as before. Also, what Laffer was selling was not a single forecast but a forecasting equation; that equation can be run with the revised data, and is still way off.

The central information in this statement is incorrect.11 Krugman got it right that people seized on later revisions to say they vindicated Laffer. He was probably referring to Wall Street Journal editor Robert Bartley’s holding up of the 1976 number in Laffer’s defense in 1992. Krugman got it right that after a few years of revision, 1971 GNP came in “quite close to” 1065, namely the 1063.4 figure of 1976. The observation that “the revisions that raised the estimate for 1971 also raised the number for 1970” is also correct. The “leaving Laffer’s growth rate as far off as before” is completely wrong. The revisions as of 1976 raised 1970 GNP by 0.6 percent, from 976.5 to 982.4. 1063.4 was a 1.8 percent increase on 1045, the modal 1971 GNP forecast at the beginning of that year. The high-end modal forecast was 1050. 1063.4 is 1.3 percent higher than that. Therefore, the 1976 revisions increased 1971 GNP above the standard forecast from the beginning of that year by either triple or more than double the revised increase-rate of 1970. Laffer’s growth rate for 1971 was not as far off as before, but rather distinctly closer.12 Moreover, when Laffer ran the model confirming the possibility of 1065 (actually 1064.5) in December, he was using full-year 1970 GNP basis figures that were in a state of flux. The General Motors strike that had lasted until November threw up hazards in the preliminary estimations of 1970 GNP. As of September, CEA had estimated fourth-quarter 1970 GNP at over $1 trillion at an annual rate. That number fell over the following months, settling around 991 (in billions) late in the year, and tipping below 990 in January. The point is that the 1970 basis number did not exist before the end of 1970 (by definition), and Laffer ran his model in December. 1064.5 was 9.0 percent above the 976.8 number for 1970 that CEA produced in its January 1971 report in which it introduced and touted “1065.” Laffer may have used a higher number than 976.8 the month before when he ran the model.

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The 1976 revision had 1971 GNP growing at 8.2 percent over 1970. Therefore the most Laffer’s model was off by was 0.8 percentage points, or less than 10 percent. This is not to mention that the purpose (in CEA’s view) of 1065 was to spur policy changes during 1971 so that the goal might be achieved. Whether these occurred is a matter of speculation. Going off gold in August was certainly not on Laffer’s menu of options. Given the 8.2 percent growth from 1970–71 officially recorded in 1976, Laffer’s model may have been fully vindicated, in that a 9 percent growth rate may have been in a reasonable range given the independent variables. It is telling that Krugman made his claims without citing figures, indeed asserting that the “equation can be run with the revised data, and is still way off” while providing nothing empirical. The clearer conclusion is that the revised data as of 1976 comported well with the ex post Laffer-Ranson forecast for 1971 GNP growth. As for the 1972 election, which took place as the nation was just beginning to contemplate the Watergate scandal, Nixon cruised to victory, defeating his opponent George McGovern in one of the greatest routs in history. The electoral-college count was 520 to 17. Nixon got over 60 percent of the popular vote, a rarity in presidential elections, and McGovern well under 40 percent. In the new administration, Shultz was secretary of the treasury. An imponderable aspect of the whole series of Watergate operations is why Nixon felt the need to proceed in it. Watergate refers to the raft of sub-legal initiatives Nixon and his associates took on to secure his re-election in 1972. Why go to extraordinary—and extralegal—means to win an election when the outcome is fated to be lopsided? Perhaps the dirty tricks produced the 60 percent popular majority and the 500-plus electoral votes. More likely the effects were marginal. Students of Watergate, and of Nixon, have spoken of an atmosphere of paranoia and mistrust that suffused the Nixon White House. In this train of thought, Watergate came not so much from a set of special results-oriented projects, illegal as they may have been, so much as was a regular product, not an excrescence, of the milieu. Watergate fit the tenor of the Nixon White House. Therefore it happened, no matter if it was necessary for actually getting re-elected. The 1065 episode compares with Watergate in a certain sense. Not in a legal sense: there was nothing illegal in this episode. Indeed it may have even been especially legal. The central advocate of 1065, McCracken, argued plausibly that a high GNP goal was consistent with the spirit of the law, of the Employment Act of 1946, and that his CEA would be the first



to meet the statutory demand for the statement of aspirational goals. Legal questions aside, 1065 bears similarities to what the Nixon White House was likely to produce, what kind of products its atmosphere typically encouraged. Like Watergate, 1065 was to some degree born of paranoia feeding determination that special measures had to be taken to ensure re-election in 1972. The proximate cause of 1065 was the domestic reaction to the announcement of the invasion of Cambodia in late April 1970. This is what prompted Kent State, Jackson State, the student strike, and (the CEA surely must have noted) the hardhat counter-rallies resulting in construction-­worker visits to the White House. Coupled with the stockmarket dive, the persisting recession, and rising unemployment, these events occasioned a crisis of confidence at CEA. It resolved to pitch in with something big to help wipe out the disorder and malaise and ensure that major results would prevail in 1972. The instrument CEA chose, to act on this drive, was the optimum feasible path, and the numbers 1070.5 and then 1065. CEA knew the entire while, from the late spring of 1970, that these figures would be above any kind of “base” forecast or modal understanding of the economics and forecasting professions. But if 1972 demanded it, CEA was going to deliver. In an important respect, Nixon himself was a force of moderation in this episode. With Shultz (and Laffer), he did not concur with McCracken that the Federal Reserve should be guided (or pressured) into 8 percent money-supply growth. Probably out of concern for putting down the 6 percent inflation of 1969 for good, Nixon was amenable to holding that strong growth could come with moderate monetary expansion. McCracken was the outlier on nominal GNP, money growth, and inflation. He wanted the first two and was willing to risk the third, all for 1972. In a way he outdid Nixon. He caught the spirit of desperation but did not pull back as others in the White House, even Nixon himself, could. McCracken’s relatively faint defense of 1065 beginning in February 1971, as that number became attached to Laffer, belies the record of 1970. From the inception, McCracken was the most ardent proponent of 1071/1065 and risking loosening money to get there. Samuelson’s tape on “Why They Are Laughing at Laffer” came in for some criticism. Allan H. Meltzer of Carnegie Mellon University, the notable monetarist, wrote Samuelson on listening to two-thirds of it and having had enough. He told Samuelson that “you were wrong about the seasonal….Laffer’s results do not depend very much on the use of

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non-­seasonally adjusted data,” that “Laffer did not forecast 1065 or any other outcome [and] gave a range of choices that policy makers could expect,” and that given the prominence of government expenditures in the model, “Why is this then an extreme form of monetarism?” He put it to Samuelson directly: “Laffer’s paper is a serious piece of work that you and others ought to discuss on its merits. It is certainly hard to understand why a scientist would so viciously attack a paper that he has not read carefully, if he read it at all. It is equally difficult to guess why you devote so much abusive and uncharitable comment to one man’s attempt to deal with some serious problems.” Friedman, who also did tapes for Instructional Dynamics, sent Laffer a copy of Samuelson’s tape and remarked about the contents: “They will with justice both amuse and infuriate you, but I thought you might want to hear them despite their unfairness.”13 One of the reasons, surely, that Samuelson was catching flak was that he had worked innuendo into “Why They Are Laughing at Laffer.” He did so in such a way as to suggest deliberateness. For example, on at least eleven occasions in the thirty-minute tape, Samuelson referred in some fashion to Laffer as a “Dr.” a “Mr.,” and a “Ph.D.” On the first several occasions, two-and-a-half minutes into the tape, after the recounting of his own remarks from February 5, Samuelson said that “on the staff of Dr. Shultz himself works a 30-year-old economist, Dr. Arthur Laffer, who is on leave from the University of Chicago, where he is an associate professor. Dr. Laffer is a Ph.D., he is trained at Stanford, and he has a little model….” Later came the bit that Slevin had an interview, “I understand, with Dr. Arthur Laffer. Dr. Laffer is 30 years old, he’s a very confident young man….” Laffer told Slevin that in 1966, he had taken 7-to-1 odds that Ronald Reagan—“Ree-gun,” Samuelson pronounced the name; Reagan was in his second term as governor of California in February 1971—would win the governor’s race. Samuelson continued, “Mr. Arthur Laffer as he then was, before he was known as a Ph.D.,” had placed the bet. A minute later, “Dr. Laffer gave a presentation of his model,” another “Dr. Laffer” after that, as well as “a relative neophyte,” before a final “I…will give credit to Mr. Laffer” if 1065 would come to pass. Several weeks after the tape went out, Samuelson gave a talk in Chicago at an economics forecasting conference, probably an event associated with the annual outlook luncheon of the Graduate School of Business. Chicago was fêting him, a bachelor’s degree recipient from the university in 1935, for winning the Nobel Prize. The subject of the talk was 1065. Later in



1971, aware that he had stirred up controversy in his treatment of Laffer in this talk, and had been criticized for it, Samuelson wrote up his recollection of what had occurred. It went as follows: “Having known and liked Arthur Laffer when he was a graduate student at Stanford”—the two had first met when Samuelson gave a lecture there, one roiled by a prank question by Laffer’s teaching assistant—“who had taught my daughter Jane (who found him a very good teacher), in one of my writings” during the 1065 controversy “I referred to him as Dr. Arthur Laffer, thinking naturally that he was a Stanford Ph.D. Somebody in Washington, perhaps it was Joseph Pechman” of Brookings, “subsequently kidded me for pinning on him the indignity of being a doctor when he was not one….So when, at the Chicago outlook conference, I was reading from my script I explicitly corrected myself and said, ‘I mean Mr. Laffer.’ Subsequently various notes were passed up to me at the head table saying that he was Dr. Laffer; and so I corrected myself once again, saying I had been confused in the matter.” Samuelson continued: There the matter ended. Except that two hours later when I was sitting in the bar talking to Lloyd and Edith Metzler, I heard myself being paged. It was a long-distance call from my old and dear friend Emile Despres. “Stop picking on Art Laffer,” he said, “he’s a nice boy and it is only a formality that stands between him and his Ph.D. degree.” I explained to Emile that I had been confused as above and had no thought of besmirching his good name. (There the story ends as far as I am concerned. I inferred that the Chicago Dean had hurried from the meeting to call up Stanford; that there had been some lack of complete information on the matter at Chicago; and I have heard from the grapevine that there was concern there about the whole matter—a concern which does no one any credit.)

And to conclude: From various vague rumors, I also infer that the above account is not what some people believe, a fact that is not in my power to change. The only moral problem I ever faced was whether for someone of my position in the profession to come out strongly in criticism of the work of a 30-year-old would do irreparable damage to his reputation. I decided on this that national policy was involved; and, further, that in the case that his forecasts proved to be right (as I doubted but could not rule out) the laugh would be strongly on me, a risk a responsible commentator ought to be prepared to take.

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Laffer did not have the Ph.D. as of 1971. This fact, as revealed by Samuelson, would decisively alter the course of Laffer’s budding career as of that spring. At this juncture lay the origins of Laffer’s turn away from academic publication and academic careerism toward the shaping of public policy. The stakes were large, in that ultimately Laffer’s influence as a shaper of policy, and of politicians interested in adopting his ideas, was notable to a high degree. The setting would be the forthcoming years of the 1970s, the nation in the grip of stagflation.14 To take leave of Samuelson as a dramatic persona in these affairs, his explanation of his “Dr.” and “Mr.” actions gave off, as was so often so in his case, the scent of baiting and plausible deniability. In the February 19 tape, Samuelson mentioned that Laffer had spoken at Brookings the previous day. Perhaps that is when he ran into Pechman. At any rate, in the tape, he was perfectly suggestive that Laffer both lacked the Ph.D. and that there might be some confusion on this score. People approximately never say, of a Ph.D. when that person was still a graduate student, “Mr. [Jones] as he then was, before he was known as a Ph.D.” Given the tape, Samuelson’s rendition of the Chicago outlook talk “Mr.” utterance loses credibility. Over several months in early 1971, Samuelson toyed in public remarks with the delicious fact he had discovered that Laffer lacked the Ph.D. He added to this the questionable behavior of misrepresenting what he was doing. That he felt it was questionable behavior is implied by his remark, “the only moral problem I ever faced,” as he mentioned something else. Samuelson was far too practiced in the circuitous arts of verbal manipulation for his “outing” of Laffer in the wake of the 1065 flap to have been anything but that. Apparently that Chicago dean did run to the telephone to call Stanford. The question is why that had not been done in 1967 or 1970. When the University of Chicago Record listed Arthur Laffer as a new assistant professor in December 1967, as it listed “instructors” as well, it implied, perhaps, that the University had checked, via registrar-to-registrar communication with Stanford, that Laffer held the Ph.D. It implied this on the assumption that the respective relevant bureaucracies were minimally thick and operational. If, however, the relevant bureaucracies, in particular Chicago’s, were not particularly called-on and thoroughgoing, as a matter of course, it stood to alter the perspective on the matter that was about to unfold. If a university does not check if its professors have Ph.Ds., does it care if its professors have Ph.Ds?



When Laffer was tenured and promoted effective the fall of 1970, he lacked the Ph.D. Conceivably he had misrepresented this fact to his superiors as these gains came his way. Just as conceivably, the superiors either assumed he had the Ph.D., and the University was not so bureaucratically driven as to check up on such matters, or they felt that Laffer’s publication record made any fact about his doctorate irrelevant. What is certain is that the Chicago authorities were sternly dissatisfied with the news several months into 1971 that Laffer lacked the Ph.D. The dean of the Graduate School of Business, the accounting scholar Sidney Davidson, set up a committee of inquest and put George Stigler in charge. As Stigler wrote to Laffer in May, “As you may know, Dean Davidson has appointed a committee…to examine the facts concerning your academic degree status, as a result of the commotion following Samuelson’s lecture. I enclose a summary of all the material we have found in the files….Would you please send to me any corrections, additions, or comments on any of this material that you wish our committee to consider and to include in its report to Dean Davidson?”15 The enclosure was a series of items dating from 1967 to 1970 and annotated by Stigler. The first items concerned Laffer’s initial appointment documents and university publications from 1967, the latter consistently identifying Laffer as “assistant professor.” The offer letter and acceptance-confirmation letters Laffer received for the position, of the first several months of 1967, specified that “if you have not completed the requirements for the doctoral degree by the time you join our faculty, your initial rank will be that of instructor, but we promote automatically to assistant professor as soon as the degree requirements are met.” To parse terms, “degree requirements,” not “degree in hand,” was the criterion for the standard tenure-track rank. In September 1967, associate dean Joseph LaRue wrote in a memorandum that “Laffer is Asst. Prof. He’s finished doctoral requirements but doesn’t have the degree yet.” The university publications from that fall quarter listed Laffer as having that rank. The early 1967 instructions to the new hire had specified “as soon as the degree requirements are met.” As the fall approached, the university was satisfied that they were, without noting the absence of a conferred degree. On that note, LaRue wrote to Laffer in October 1967 that he understood “that you had completed doctoral requirements and that your rank here is now that of Assistant Professor. Would you let us know when the degree has been conferred so that we can note this in our appropriate records?” As Stigler observed, “this request was repeated in similar language” in another

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communication in November. Laffer’s reply late that month went, “My advisor has indicated that my dissertation is acceptable and therefore all the substantive doctoral requirements have been fulfilled. I don’t know, but believe that I shall officially receive my degree this coming June 1968.” Laffer’s vita of October 1968 listed “Ph.D. (Economics), Stanford University, 1969.” A federal form Laffer had signed, in December 1968, when the incoming Nixon administration had first sought him out for prospective service, had the line, “Stanford University, 9/65—6/67…Ph.D.,” with “the last line being under the heading ‘degrees,’” as Stigler noted. Laffer had included this form in a submission to the dean’s office in September 1969 and in a National Science Foundation proposal he had done (successfully) with Fama. This form, Stigler noted, also included this explanation from Laffer: “My dissertation was revised for publication as a Brookings book, September 1968. This was accepted for publication by Brookings and later rejected. I do not plan to do anything with this manuscript.” The last item was a record of a conversation. Sometime in 1969 or early 1970, in response to an outside query, Dean LaRue “went to Laffer and was told that he had the degree, and that it was received in 1967.” As Stigler pointed out, “our announcements listed only an MBA until September 3, 1970.”16 It was quite a mess. The university explicitly required fulfilling requirements for the degree, not the degree itself, at least in communication with the new hire in question. Of the two pieces of evidence showing that Laffer claimed to have the degree, one was hearsay (the comment to LaRue) and the other (the federal form) was a long document that may have been filled out by an administrative assistant. Laffer responded to Stigler with a list of his own. He pointed out that his resume on file with OMB listed “Ph.D. dissertation defense, ’68.” Then he went into hearsay questions. He understood that Shultz, Fama, and other faculty members had over the years spoken of himself as not having the degree. He asked Stigler, “as a personal request I would be very grateful if you would double-­check the statement attributed to Joe LaRue.” In terms of providing additional materials, Laffer came clean with Stigler about some regrets. One of these was not completing the revisions to the “Anti-Traditional” paper once it had been accepted by the AER. He conceded that he had not completed the paper even though the requests were “relatively minor” and even if that work was covered in his further papers in the NBER volume (on intermediation) and on trade credit. He said that he had wanted to work on the paper in the summer of 1970, but that his “Washington job,” and presumably his work on “A Formal Model



of the Economy,” had made this impossible. He noted how widely discussed the paper had been in any case and that “after the recent set of events, I intend to move swiftly on this paper.” It is possible that had Laffer had an important article in the AER just prior to the spring of 1971, and on the heels of all his other publications, the revelation of his not having the Ph.D. might not have been harmful to him—but rather to the very convention of getting the degree. As for the dissertation, until recently, as he wrote to Stigler, “I had not been aware of the importance of officially receiving my Ph.D. I had felt then that it was sufficient to have completed Stanford’s Ph.D. program’s substantive requirements.” When he wrote this, the Stigler committee had already furnished him with its evidence indicating that the importance that was stressed to him at the time concerned “requirements,” with petitions added on about letting the dean’s office know when he got the degree. Laffer continued, “I intended to fulfill all of the remaining requirements, but had not felt any sense of urgency. I was not secretive about the fact that I had not officially received the degree. After…coming to Chicago, other projects seemed to be of higher priority to me.” Laffer conceded that “it is now clear to me that my priorities were misplaced and that I should have completed the final requirements for the Ph.D.” Curiously here, he couched his wording in terms of “requirements” as opposed to receiving the degree. “Several weeks ago” (this was May 1971) “I set the process in motion again and should be able to have definitive results in the not-too-distant future.”17 The Stigler committee reported to the dean, and the recommendation it implied was serious. As Robert Leeson uncovered the relevant passage of the report in the University of Chicago archives: “Laffer became an assistant and then an associate professor without fulfilling the known requirements for these appointments and at a very minimum permitted misunderstandings favorable to himself to persist. We consider this conduct deplorable….This cloud of suspicion, whether of judgement or character, introduces a serious impairment of Laffer’s value to the University of Chicago.” Nonetheless the dean, Davidson, dropped the matter. As he wrote to Laffer in July, a month after the Stigler committee made its report, he and the university provost John Wilson “discussed the question of formal action by the University on this matter. I told him I would not recommend formal action. John Wilson assured me that the central administration would not initiate such action. That question is then

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settled; no formal action will be taken.” The matter was closed. Laffer would remain a tenured faculty member at the school of business.18 How such a chain of events came to pass—and what it might signify in some historical and sociological sense—remain matters of speculation. It was odd that Laffer did not close the matter at some point shortly after the spring of 1967 and get the degree. Clearly from his departure from Stanford in 1967 through 1971 he had the support of his adviser Despres, as the pair’s year at Brookings and Despres’s phone call to Samuelson showed. Despres said consistently that he felt the dissertation was finished. Submitting it to Brookings for publication in 1968 was also tantamount to Despres’s holding it was finished. Nonetheless, Despres’s conviction that the dissertation was finished itself served to advance the problem. The certainty of his adviser’s approval enabled Laffer to say with plausibility that he had all but fulfilled the requirements for the degree. The dissertation was an extension of Laffer’s 1967 AER piece on short-­ term capital flows, which Laffer had written at the Cleveland Federal Reserve in the summer of 1965. The topic was a chink through which one could see the larger, more general issues that Laffer took up in later papers such as “An Anti-Traditional Theory of the Balance of Payments Under Fixed Exchange Rates.” That he may have lost interest in taking care of the dissertation, in particular after the negative review for publication by Brookings came, found a parallel in his desultory approach to getting that very paper in the AER. When the “Anti-Traditional” paper was at the cusp of top-tier publication, the next big thing, the OMB job, was coming his way. He kept dropping existing projects just as they were about to be finished for new ones. It cannot be discounted that Laffer may have been, to some degree, intentionally reckless, even snooty, in not pursuing his Ph.D. to completion as he got appointed to and then held a tenure-track professorship. He was young, twenty-six in the spring of 1967 when the job offers came and twenty-nine when tenured at Chicago three years later. He was the son of a Fortune 500 CEO, had been educated privately his whole life, and sat on the Chicago faculty among a good number of professors who were first-­ generation successes. The manners and degree of chic of these faculty—as the photo gallery on the webpage of economist Robert Gordon (who was an assistant professor at Chicago at the time) attests—were low. Laffer remembers his society mother’s visiting him at Chicago and wondering why he might associate with such people. Laffer’s brother, a math professor at a state university and the official intellectual and absent-minded



professor of the family, had to tell their mother that this position of Arthur’s was the top of the heap. Molly and William G. Laffer soon retired from Cleveland to tony Rancho Santa Fe California, where William’s best friend at the bar was Neil “Moon” Reagan, the advertising executive and brother of the president.19 William James began his 1903 essay, “The Ph.D. Octopus,” as follows: Some years ago, we had at our Harvard Graduate School a very brilliant student of Philosophy, who, after leaving us and supporting himself by literary labor for three years, received an appointment to teach English Literature at a sister-institution of learning. The governors of this institution, however, had no sooner communicated the appointment than they made the awful discovery that they had enrolled upon their staff a person who was unprovided with the Ph.D. degree. The man in question had been satisfied to work at Philosophy for her own sweet (or bitter) sake, and had disdained to consider that an academic bauble should be his reward.

James observed that “America is thus a nation rapidly drifting towards a state of things in which no man of science or letters will be accounted respectable unless some kind of badge or diploma is stamped upon him…. It seems to me high time to rouse ourselves to consciousness, and to cast a critical eye upon this decidedly grotesque tendency.”20 The Ph.D. was an especially American institution, that credential signifying the research university as emerged in the post-civil-war era and typified by Charles William Eliot’s Harvard which employed James. It was a tradition still in force, in Britain at least in the 1960s, for those graduate students who felt that they were the best not to “take” the D.  Phil. or Ph.D. from Oxford or Cambridge, even not to apply for the degree once its requirements had been fulfilled, because degrees implying professional licensure smacked of the petty-bourgeois and the non-aristocratic. Harry Johnson noted as much, making the astute observation that British academics were more integrated into society than American academics, who formed a comparatively déclassé society of their own. Johnson wrote on the basis of his experience shuttling among the economics circles of the Anglosphere, as quoted by his biographer D. E. Moggridge: “Possession of a Ph.D. by those who would make their careers in…[Britain] (in university or elsewhere) frequently…[denoted] insufficient competence, personal charm, or quickness of wit, to achieve academic appointment without one (though often the Ph.D. is necessary to enable the student from a

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backward country to break into the charmed concentric circles of British academic life).” Still in play in the 1960s was snobbery that that those with Ph.Ds needed them because of their lack of social standing or graces. Perhaps a kind of academic gamesmanship and haughtiness played a role in the course of action Laffer took with his degree, as he published in the top places, won tenure at Chicago, and took a high position in Washington at tender ages, sans Ph.D.21 Having escaped the axe from the university, Laffer got busy with getting signatures on his dissertation-completion form so he could apply for and get the degree. Despres had taken sick during the Brookings leave and was still recovering (he would die in 1973). The department added a replacement reader, Tibor Scitovsky, who wanted substantive changes to the dissertation. Edward Shaw and Ronald McKinnon, the other original readers, wanted updates from Laffer’s existing manuscript. The dataset was appropriate for 1967 but not for four years later. Laffer did the work and late in 1971 got an unusual four signatures. Despres rallied and signed as well. Stanford conferred the degree in January 1972. In a last note of farce, in calligraphy the Ph.D. diploma spelled his name “Authur” Laffer.

“The Destiny of Man” In the “Why They Are Laughing at Laffer” tape, Samuelson remarked of Laffer and 1065 “that a number like his should  change the destiny of man.” At another point, Samuelson wondered if the administration had inserted 1065 into the budget and the economic report for “high reasons of state.” Or as the New York Times poem having sport with Laffer’s model put it, “the stakes are so high.” Whatever the importance of a president’s submission of a budget framework to Congress early each year, and whatever the importance of the CEA’s annual report, it is unlikely that target GNP numbers will directly affect destiny writ large. Governments can take steps to affect such destiny, however. What the Nixon administration did the August following the 1065 controversy is an example. This was ending the gold standard. The decades since 1971 have been a unique period of world monetary history, particularly in times of peace, one in which the major currencies of the world have not defined themselves as weights of precious metal. There were paper and other fiat-money eras in the past, including in medieval



China, but a global system without precious-metal definition on the part of any major currency is possibly singular. On August 15, 1971, Nixon announced that the United States would no longer honor requests from foreign monetary authorities (the only ones left who could make such requests) to redeem their dollars in gold for $35 per ounce. There has not been a resumption of anything approaching a precious-metal system since. That this move was epochal is difficult to gainsay. One development it touched off was the growth of finance as an economic sector, inclusive of the rise of currency-trading. Currency-trading has become perhaps the largest market in the world, amounting to some $6 trillion in turnover daily, exceeding in size arguably all other markets, even in stocks and real estate, about which George Gilder has eloquently written. Bank of International Settlements reports since 1971 have consistently marveled at the massive rate of growth in global currency turnover, often over 10 percent per year. Going off gold and fixed rates appears to have been the basis of the take-off of this industry—and the allocation of resources toward it from other investment vehicles relating to prosperity traditionally defined, the production of goods and services. Then there is the march of the price level. The consumer price index (CPI) in the United States took off in the 1970s, moderating to a small but certain rate of increase thereafter. In the five decades after 1971, the CPI rose over six-fold. There had never been anything like this in the past. As of the 1960s, the CPI was perhaps three times larger than the steady-state of the nineteenth century. Taking inflation into account, average stock prices fell by about 75 percent from the 1966 peak to the 1982 trough.22 In American history since the ratification of the Constitution, “specie” standards of some sort had been the norm outside of wartime. Even in 1933, when President Franklin D. Roosevelt rendered private gold ownership illegal, he maintained dollar-gold redemption with foreign parties. Specie suspensions occurred during the War of 1812, the civil war and its aftermath, and in 1917 as the nation joined the Great War. Otherwise prior to 1971, the United States had never maintained a lasting abrogation of the currency’s definition in precious metal. This came in 1971. Mundell joined those who called the result a “non-system.” In his “order” and “system” framework, Mundell proposed that the nature of any given society and economy (order) implies a certain kind of comporting monetary arrangement (system). Monetary order finds realization when the monetary system it gets is consistent with it. Mundell and Laffer

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would spend the 1970s openly mocking the United States for failing to even care about having a monetary system that responded to the population’s preferences and hopes, the monetary order. A dollar depreciating at double-digit yearly rates, inflation a scourge to wages and fixed income and the butt of jokes, a “malaise” as President Jimmy Carter all but put it gripping the country on account of the comprehensive price increases, these bywords of the 1970s were signals in the Mundell analysis that system had badly dissociated itself from order.23 In free-market theory, perhaps, there should have been a market correction. If government money is failing to deliver what people want, alternatives will arise and solve the problem. Friedman felt that floating exchange rates expressed currencies competing against each other in the market. Laffer’s criticism was that floating rates eliminated currency competition. They did so by eliminating the definition of the things involved in the competition. An analogy might be runners in a 100-meter dash. They are competing against each other qua runners. If they are allowed to be many other things, something undetermined, a swimmer or a knitter or something unknown and changeable, their competition against each other in the 100-meter dash loses all sense. When currencies lack explicit definition, what one is getting in buying them is unclear. When they have explicit definition, in the Laffer analysis, arbitrage can readily identify the most efficient producer. An essential aspect of the currency non-system after 1971 was American hegemony. In previous eras, if there was an inefficient currency producer under the standard dollar definition, that producer lost business quickly or shaped up. In the era of bank-issued dollars, which lasted until the establishment of the Federal Reserve in 1913, dollar production as undertaken by innumerable private entities was consistent with a CPI steady at par and long-term economic growth now measurable in the yearly range of 4–6 percent. After 1913, the United States less sought out monetary responsibilities as let them come to it—an indication, perhaps, of the workings of “order.” The immense foreign gold flows into the United States in the late 1930s and early 1940s came care of transactions of private parties. In a fateful move, the United States then decided, at Bretton Woods, that this enormous national gold stock (started as it had been by the 1933 confiscation) had primary systemic significance. The United States would redeem in gold because it had it already. This elided a definition. In specie standards of the past, the assumption was not that an issuer had specie but



could readily acquire it in anticipation of a request for redemption. The reasonableness of having issued the currency in the first place was the guarantee that its issuer could scrape up gold (or silver) for redemption. Moreover, redemption requests would remain low so long as widely usable money, currency, was valuable in the marketplace. To the degree that rates of return on investment were high, there would be disproportionate demand for currency over non-returning specie. By 1971, the dollar price of gold was the global market price. This made it impossible for others, France perhaps, to define their currency in gold. The franc would swing wildly (in an arc of steep appreciation) against the dollar and thus all notable currencies, on account of the dollar’s dominance in the global marketplace. In the Mundell terms, in going off gold the United States effectively imposed a system disrespectful of order because it could. Order responded by such means as the absurd commodity price spikes, the inflation, the manic trading in currencies, and public fury over what was happening. And still the assertion of the privileges of system over order came at the expense of the real economy, via stagflation. This could not have happened if the United States had not been acutely powerful. If this global hegemon had been distinctly less powerful, going off gold would have shouldered aside the dollar as a desirable currency. It was a case of the United States acting in a self-absorbed fashion, if unconsciously, of failing to recognize the fact and gravity of its noblesse oblige. The flap over 1065 set up this denouement to some degree. There was no national conversation on going off the gold standard in the first months of 1971. All talk, as Samuelson correctly accounted it, was on 1065. How useful this proved for the decision that came out on August 15. Suddenly, the United States dispensed with the gold standard. The dollar would be fiat. To be sure, the monetary and international macro sections of the economics profession, and the policymakers and discussants who entertained the views of these economists, had been talking about the untenability of the international monetary status quo incessantly since the late 1950s. But at the juncture at which the policy switched, there was an eerie silence, as comparatively insignificant matters such as 1065 stormed for attention. The 1065 chatter covered for going off gold. Laffer had sensed something was up. With CEA’s Hendrik Houthakker and Treasury’s Paul Volcker, he was a member of the “Volcker Group” on the balance of payments which invariably told policymakers to calm down about the perceived problem. As Nixon’s international economics assistant Peter G.  Peterson said of the Volcker Group in March 1971,

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“Everything I’ve heard is that this is one of the best interagency groups in the Government.” Among the innumerable memos that Laffer sent to Shultz in 1970 and early 1971, one in particular would prove to have foresight—as an outline of his future activities. In March, Laffer had Shultz read a paper of Mundell’s, probably a version of “The Dollar and the Policy Mix: 1971,” published by a Princeton University organ the following May. “Bob recommends a reduction in taxes as being an important stimulant to the economy,” as Laffer wrote Shultz. “He could very easily be right. In the model, we are unable to test all hypotheses,” including “a discrete change in tax rates. He is asserting a discrete change in tax rates”— a tax-rate cut—“will have a very positive effect and will operate, to a large extent, through the demand for money.” This was, Laffer noted, “consistent with our reasoning.” With the dollar off gold and Laffer in a compromised position in the academy as of that summer, his attention and ambition would flow into precisely this area. In this next phase of his early career, he would be ever less a scholarly researcher and ever more a policy-­ intellectual entrepreneur offering a solution for stagflation.24

Notes 1. “Glowing Forecast Highlights Budget of $229.2 Billion,” WSJ, Feb. 1, 1971; Frank C. Porter, “Budget Looks to Upturn,” WP, Jan. 30, 1971; Eileen Shanahan, “Strong Economic Gain Predicted,” NYT, Jan. 30, 1971. 2. Leonard S. Silk, “Nixon’s Budget Mystery,” NYT, Feb. 3, 1971. 3. Hobart Rowen, “Record GNP Figure Came From Council,” WP, Feb. 4, 1971. 4. See “The 1971 Economic Report of the President,” Hearings before the Joint Economic Committee, 92nd Congress, 1st Session, Part I, Feb. 5, 9, 17, 18, and 19, 1971; Silk, “Electronic Bullishness,” NYT, Feb. 10, 1971. 5. Hobart Rowen, “Friedman Doesn’t Buy Laffer ‘Money Machine,’” WP, Feb. 14, 1971. 6. “Tape 69—1971; there’s good news tonight,” Feb. 5, and “Tape 70— Why they are laughing at Laffer” (audio recordings with transcript), Feb. 19, 1971, Economics Cassette Series, Paul A.  Samuelson Papers, Duke University [hereafter Samuelson papers]. The quotations from the following paragraphs are from this source. 7. Paul A.  Samuelson, Economics: An Introductory Analysis, 4th ed. (New York: McGraw-Hill, 1958), 222, 247. 8. Joseph R.  Slevin, “Laffer: Whiz Kid Who’s ‘Not Afraid,’” WP, Feb. 14, 1971.



9. Laffer to Shultz, “Comments on Chapter 2 of the Economic Report,” Jan. 20, 1971, OMB file, Laffer archive. 10. Rowen, “Record GNP Figure Came From Council”; Alfred Priori, “Money Machine,” NYT, May 16, 1971. 11. Paul R. Krugman, Peddling Prosperity: Economic Sense and Nonsense in the Age of Diminished Expectations (New York: W.W. Norton, 1995), 86n–87n. 12. Robert L.  Bartley, The Seven Fat Years: And How to Do It Again (New York: The Free Press, 1995), 43; U.S.  Bureau of the Census, Statistical Abstract of the United States: 1971 (Washington, DC: 92nd ed.), 306; Statistical Abstract of the United States: 1976 (97th ed.), 394. 13. Meltzer to Samuelson, March 11, 1971, Meltzer file; Friedman to Laffer, March 3, 1971, Friedman file, Laffer archive. 14. Paul A. Samuelson, “File under Arthur Laffer: Harold Freeman, here is my account,” n.d. (circa late 1971), “Laffer, Arthur, 1971” folder, Box 47, Correspondence Series, Samuelson papers. 15. George J. Stigler to Laffer, May 10, 1971, Stigler file, Laffer archive. 16. Enclosure to Stigler letter to Laffer, May 10, 1971; Laffer to Stigler, May 17, 1971, Laffer archive. 17. Enclosure to Laffer letter to Stigler, May 24, 1971, Laffer archive. 18. Leeson, Ideology and the International Economy, 189n7; Sidney Davidson to Laffer, July 2, 1971, Laffer archive. 19. Robert J.  Gordon, “Photos of Economists: Super-Antiques Photos,”­gordon/photo-­ landing.php?dir=Super-­Antiques. 20. William James, “The Ph.D. Octopus,” Harvard Monthly 36, no. 1 (March 1903), 1, 3. 21. D.E.  Moggridge, Harry Johnson: A Life in Economics (Cambridge, UK: Cambridge University Press, 2008), 329. 22. See the various BIS Triennial Central Bank Surveys ( and George Gilder, The Scandal of Money: Why Wall Street Recovers but Main Street Never Does (Washington, DC: Regnery, 2016). 23. Alec Chrystal, review of The New International Monetary System, by Robert A. Mundell and Jacques J. Polak, Economic Journal 88, no. 352 (Dec. 1978), 851; Mundell in 2003: “The IMF mistakenly champions the non-system of flexible exchange rates and derides the fixed exchange rate policies as vigorously and dogmatically as the IMF in the 1950s and 1960s championed fixed exchange rates!” Mundell, “The International Monetary System and the Case for a World Currency,” Leon Kozminski Academy of Entrepreneurship and Management…Distinguished Lecture Series, Warsaw, Oct. 23, 2003, p.14,; Mundell’s elaboration of a “system”/”order” distinction came in “The Future of the

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International Financial System,” in Bretton Woods Revisited: Evaluations of the International Monetary Fund and the International Bank for Reconstruction and Development, eds. A.L.K. Acheson, J.F. Chant, and M.F.J. Prachowny (Toronto: University of Toronto Press, 1972). 24. Peter G. Peterson, “Memorandum for Paul A. Volcker [et al.],” March 30, 1971, Foreign Relations of the United States, 1969–1976, Vol. III, Foreign Economic Policy, International Monetary Policy, 1969–1972, ed. Bruce F. Duncombe (Washington, DC: GPO, 2002), Document 59; Mundell, “The Dollar and the Policy Mix: 1971,” Essays in International Finance 85, Princeton University, May 1971; Laffer to Shultz, “Memorandum for the Director,” March 9, 1971, OMB file, Laffer archive.


Toward the Policy Mix

In September 1966, as he assumed his full professorship at the University of Chicago, Mundell gave testimony before the Joint Economic Committee of Congress. Representative Henry Reuss asked him in regard to his prepared statement, “would you agree, yourself,…as to whether free worldwide discussions of matters like monetary reform, and, for that matter, balance of payments…and some of the other subjects, should not be elevated to a heads-of-government level on a multilateral basis, where the technical level of discussions which have gone on for the last many years is rarely adequate to the gravity of the problem.” Mundell responded: “I have mixed feelings about that. On the long-­ run issue of monetary reform, I think the technical expertise of the individual treasuries and central banks is necessary, and while they should be prodded in this direction, they can’t be commanded to come up with an idea that is politically acceptable to the group when the political framework in which the reform is to take place isn’t really established.”1 It was an interesting premise that Reuss had, that there was a “problem”—namely monetary reform and its high adjuncts including issues within the balance of payments—and that “gravity” was its degree. Reuss assumed this premise. The justification appears to have been the continual nature of “technical…discussions” regarding the problem. The trait of those discussions tipping off the gravity was that they “have gone on for the last many years.” Why had global leaders not been talking about this © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 B. Domitrovic, The Emergence of Arthur Laffer, Archival Insights into the Evolution of Economics,




themselves as a matter of course, Reuss asked, disregarding the fact that leaders often had been doing just that. Problems of gravity were appropriate not to the level of the technocrats but high political leadership. In having “mixed feelings,” Mundell cast doubt on the premise. His remark that “the political framework in which the reform is to take place isn’t really established” was tantamount to saying that generally, people did not much care about this issue. It perhaps also implied that there was a broad political wisdom holding that this matter was overplayed and over-­ discussed. His use of the word “commanded” captured the nub of the matter. If technocrats have to be “commanded,” either something is wrong with them or, probably Mundell’s concern, those doing the commanding are out-of-touch with the proper priorities of the democratic populace. In byplay such as this—there must have been innumerable examples in all the talk about the international monetary crisis in the 1960s and early 1970s—the odd way in which the issue was playing out in the historical process stood to be revealed. That there was a large set of economists and officials urging a big move away from Bretton Woods was certain. Beyond that, however, it was unclear if there was any fundamental reality to the issue. Historian Harold James touched on these matters in an essay from 2004. As he wrote in review of a book on the purported crisis, Francis J. Gavin’s Gold, Dollars, and Power: “The heavy dependence on archives makes, I think, for a greater sense of crisis about the whole decade than is really warranted by a comparison of the 1960s with other eras. Policymakers live and breathe in a world of continual problems and crises: that is how they carve out their influence. Reading this book…has a paradoxically reassuring effect: that the policymakers and journalists”—he could have mentioned economists as well—“can be very worried, but the problems are still fundamentally manageable.” As Gavin’s book detailed, such affairs as monetary deliberations between President Lyndon B.  Johnson and German Chancellor Ludwig Erhard, much less those involving French premier Charles de Gaulle, “were envisaged by officials as [representing] ‘one of the most important decisions the U.S. has faced in the postwar period.’” “Such language,” James continued, raises the important issue of whether we should take the crisis rhetoric at face value. There was not in the end any major clash in this case, at least not something that deserves to go into the textbooks….There is…no evidence



the financial worries, however acute they were, actually constrained U.S. geopolitical decisions. Was there even one fewer U.S. soldier in South East Asia as a result of concerns about the dollar?…When modern neo-Gaullists…say that U.S. deficits are not acceptable and cannot last, are they right or wrong? And over what time period is the appropriate calculation about ‘cannot last’? The major contribution of this book, in my opinion, is to draw attention to the relationship between the language of crisis in international monetary relations and the underlying economics which are not necessarily driven by political crisis.2

That was the indeterminate relationship: “The language of crisis in international monetary relations and the underlying economics.” In the Hegelian terminology, this is a question of base and superstructure. Base “conditions” imply corresponding kinds of “superstructures” to accompany them. Conditions are “objective,” and corresponding superstructures are fitting and appropriate to the degree that they reflect this objectivity. Objective base conditions refer to the hard material constraints of a society—to the extent it is agricultural, industrial, or technological— and to embedded social conventions such as the received class structure. Superstructures are the adjunctive lifestyle forms that arise and operate in a given set of base conditions. It was a serious matter, in the Hegelian tradition, that there be a close correspondence between base and superstructure, specifically that superstructure be true to base. If a superstructural form such as a bureaucracy, for example, operates according to its own narrow priorities and independently from socio-economic base, that bureaucracy in not being integrated with the more fundamental part of the whole will fail to serve that whole. Analysis along these lines is applicable in the case of the fate of the monetary system circa 1971 on several criteria. The first is Mundell’s order/ system schema, which Mundell was surely alluding to in his remarks to Reuss. Order represents a society’s implicit and fundamental sense of proper money arrangements, and system what the arrangements actually are. The two at variance is a problem. Mundell referred to “the managers of the system” to Reuss; there can be no “managers of the order,” because order is primal.3 The second criterion is as Harold James describes. There was incessant talk among notable professional and official groups about a monetary crisis, but it conceivably did not exist. Nonetheless, monetary arrangements changed much along the lines favored by the chattering classes—a peculiar development that according to the Hegelian theory cannot have been



positive. These perspectives are comparable to, and surely derivative from, Aristotelian concepts of telos and political constitutions. In the Aristotelian tradition, the particular wisdom of political leadership is to intuit the possible reach of the vital force, the “potentiality” of the broad socio-political unit in question, and by that intuition design arrangements that can bring that potentiality to realization. The point is certainly not to design arrangements that are inappropriate to the imperatives of the polis. As for Paul Baran, here was an heir of the Frankfurt School happy to instruct an eager Stanford Business School student in 1963 in the mysteries of “the political economy of growth” and manifested elective affinities with this student for some impalpable reason. It was an article of faith in the Frankfurt School that superstructure must not cultivate heedlessness regarding its obligations toward base. It was also an article of faith that superstructure not indulge base but strive to lead it intelligently where shrewdly possible. To some degree, superstructure had to act as an avant-­ garde, but it had to be clearheaded so as to make the right decisions. Was it the right decision to upend the monetary system? A judgment such as this had to be weighed carefully in a credibly enlightened manner, and with a preference for the existing conditions. The problem was that the international macroeconomic set’s fascination with doing the reform had a momentum of its own. Where Laffer stood was clear. As of 1971, he had been proving to his editors’ and blind reviewers’ satisfaction, in major journals and proceedings, that the full-scale operation of the world monetary system showed no reason for superstructural interventions, especially of a fundamental variety such as abrogating the gold anchor and threatening fixed rates. Laffer all but said that conditions were flourishing under current arrangements, meaning that the existing superstructure was doing its job. Big unwarranted superstructural changes could conceivably bring anything, including ending the flourishing of the base. As for answers to the supposedly difficult questions offered by the proponents of crisis, Laffer’s and Mundell’s were direct. Mundell’s point about the demand for gold, as outlined in Monetary Theory, was a case in point. If everyone in the world economy gets rich, there will be greater demand for gold, because gold is an item in asset-holders’ portfolios, if mainly as a hedge against risk if not calamity. However, there is a major countervailing effect. Everyone’s getting rich means that the investment environment is excellent. Therefore, the demand for currency over gold— including under a gold standard—will be sharp. Given growth, the final



constraint of the gold standard devolves to the small matter of gold’s allocation within wealth portfolios. Given, furthermore, that growth diversifies and expands the asset base, and therefore the kinds of things represented in portfolios including new forms of calamity-hedges, the gold-shortage problem was probably fantastical. A conceit has prevailed since 1971 that gold and fixed rates expired because the intellectual momentum of a sophisticated society overwhelmed these holdovers from quainter times. The argument at the core of the conceit characteristically has the form of an ad verecundiam (false authority) fallacy. Because there were prestigious economics departments and journals, because the field was mathematical, because there was a Nobel Prize in economics, because there were major institutions such as the IMF, the Federal Reserve, and the likes of Brookings and the National Bureau of Economic Research—because there was the Ph.D. degree as a top credential at last in full flower—the weight of these authorities preponderantly expressing skepticism about gold and fixed rates settled the issue argumentatively. Gold and fixed rates were in fact obsolete. The basis of arguments of this stripe was the subjective status of the authorities. The arguments lacked warrant showing that the authorities actually were authorities in an objective sense. The likelihood that a society of such transformative affluence as the United States in the 1960s and early 1970s would cede decision-making authority to a class of intellectuals, no matter how credentialed and professionally placed for being smart, surely was passing small. Nonetheless it appears to have happened. To be sure, the issue cannot be settled among historians humbler than the Hegelian. Questions of this nature brush too closely upon the core of the ultimately unapproachable world-historical process. A point that can be made analytically is that the commonplace that gold and fixed rates lost out because they failed intellectual tests disrespects two heavy realities. First, base possesses enormous vital power; second, the connection between superstructure and base is a surpassingly difficult matter to explain. What is easy to say is that as gold and fixed rates faded out in the early 1970s, on came stagflation. In all appropriateness, this is the moment when Laffer began his transition toward being a “crank.” This is when his journal production topped out, he began to experience condescension and shunning in the academy, his publications became generally non-peer reviewed, and his audiences and patrons increasingly included ambitious political backbenchers. It all worked together. The Ph.D. controversy happened at precisely the right



time to expectorate this formidable young advocate of gold and fixed rates from, to use the common term, the “mainstream” of academic-intellectual discourse and institutions. It happened to Mundell too. In 1971, he quite astonishingly left his professorship at University of Chicago, for the parochial outpost of the University of Waterloo in his native Ontario. It was probably because of bullying. Mundell was a gentler soul and from more humble origins than the prepped Laffer, who had come of age in the hurly-burly environment of an elite bent on fighting to replicate itself and was pleased to return attempts at attacks in kind. Mundell once remarked, to Laffer’s wife Patricia, that Laffer was one of the most ruthless persons he had ever come across. Once gold and fixed rates fell out, there was no warm high place for these two in the victorious economics establishment anymore. Conceivably, there would have been if the victory had been legitimate, if it had not been tainted with phoniness. A big-hearted establishment would have kept them on as sparring partners, or at least as ornaments. But that would have required confidence. If there was something doggedly dishonest about the dismissing of the monetary system of the ages—any kind of specie standard—and the fixed rates it involved, grounds for confidence were lacking. The exile of Laffer and Mundell was perhaps in the better part self-inflicted. But it corresponded as well to the imperatives of an economics establishment that could no longer bear to hear their views. In studies of the intellectual field theory of sociologist Pierre Bourdieu, scholars have spoken of those groups that have striven (perhaps unconsciously) to use the pursuit of the intellectual life as a method for gaining prestige and power at the expense of the received social and political structure. In the large subfield of the “sociology of knowledge” inspired by Kuhn’s Structure of Scientific Revolutions, any “paradigm shift” that occurs within an intellectual community is assumed to have close connections to the sociological ambitions of that community. All these perspectives, from the Aristotelian to those of Mundell, the Frankfurt School, and Harold James, lend credence to the view that the international monetary crisis of the 1960s and early 1970s was heavy on sound and fury and signified in some good part the distended ambitions of a rising academic and policy stratum.4 As Laffer became alienated from the academic component of superstructure, he compensated with large moves into the bosom of base, where he was welcomed as a bona fide academic intellectual. As his journal publication and so forth dropped off, he became a consultant to successive



secretaries of the treasury (Shultz and William E. Simon) and to the chief of staff and secretary of defense (Donald H. Rumsfeld); he published in and advised the editorial leadership of the dean of the business press The Wall Street Journal, as its editorial page broke out of quotidian concerns and pressed for intellectual progress in economics; and on finding academic circles unwelcoming, he began to reintegrate himself into the high society that had been his birthright. This latter experience, largely dating from his departure from Chicago to California in 1976, is detailed in that extraordinary entry in pre-presidential history, Bob Colacello’s Ronnie & Nancy (2004). Rarely in these communities did Laffer find his peer qua economist. He was the economist, in these contexts, explaining to these receptive practical audiences his vision, now that the scholarly world had found fit not to contemplate him anymore. The contemporary historiographical movement of the “new history of capitalism” can be prone to treat developments such as these superficially. Laffer got in over his head in academics as a conservative, naturally got run out, and then elements of the business establishment picked him up as a tool to ram through their pet causes, above all tax cuts, the argument generally runs. Arguments in this vein do not evince respect for the profundities of base and superstructure. In the first place, they assume a rather free-floating and legitimate academic-economics superstructure, the group that hounded Laffer out. In no robust sociology of knowledge can a discourse community such as academic economics circa 1971 not be seen as heavily determined by social-psychological oddities and the mandates of competition with base for resources, prestige, and perquisites. In the second place, arguments about Laffer’s being a conservative crank have functioned to relieve historians of their procedural responsibilities. The critics of supply-side economics in the high academic organs have barely read or cited anything in the tradition. The events here detailed largely belong to half a century ago, yet the easy majority of the citations of the subject, in the present volume, has never seen the light of treatment in historiography. Supply-side economics was without question the most consequential economic-policy revolution-movement since the New Deal, and Laffer and Mundell were without question, and such as they were, its intellectual lodestars. The proposition that their extensive written and spoken comments in the long preparatory period to 1981 and the Reagan Revolution not be attended to with care and diligence, and a critical sense as well, is inconsistent with the processes of necessary historical understanding.5



About the word “crank,” it is a curious one to use as an epithet in the realm of economics. The term comes from “crankshaft,” and the tinkerers in ramshackle outbuildings who had a fever to invent something in the nineteenth and early twentieth centuries. These are the people who in good part propelled the industrial revolution. Cyrus McCormick, George Westinghouse, Alexander Graham Bell, and Nikola Tesla, if as well their innumerable counterparts who were unsuccessful, were cranks on any reasonable definition of the term. Surely as well were Hedy Lamarr and Steve Jobs. The crank, when successful, is precisely that figure who travels from base to show clueless superstructure (in this case the big corporate research outfits) how to make an advance. Given the rather hideous unfolding of stagflation in the 1970s and then its welcome abrupt departure in the 1980s, the term is perhaps apt in Laffer’s case, and not as an epithet.

Back to Academia Laffer’s first year at OMB, 1970–71, was a whirlwind. The following year, through the spring of 1972, was comparatively uneventful. He was busy with untold tasks relating to the work of the OMB and the Volcker Group. The importance of the overarching economic issues had snuffed out tempests such as 1065 and forced attention elsewhere. First, there appeared to be a respectable economic recovery taking place. The business-cycle-­ dating authorities identified an expansion from late 1970 through the first part of 1973. Economic output was growing at a measured real rate upwards of 5 percent per year. However, accompanying the closing of the gold window in August 1971, Nixon imposed wage and price controls. Inventories built up, as did investments in productive resources, as suppliers waited for the controls to break. This brought increases in GNP without final sales—without a comparable increase in the experience of the standard of living. Shortages, in particular of food and other grocery-store staples, emerged even as there was a GNP swell. On the news that one of the items now in short supply was toilet paper, on the Tonight Show Johnny Carson joked, “we got to quit writing on it!”6 Inflation was statistically somewhat moderate in these years, 3 or 4 percent per year. The controls, however, masked the higher clearing price of supply and demand. Officially it appeared that the current period had bettered the 5–6 percent inflation rates of 1969–70. But it came at the cost of an “incomes policy,” as administration economists referred to the controls, which reduced the availability of retail goods and the deployment of



capital goods in production. Whether the inflation problem had been really dealt with, therefore, was a second nettlesome problem confronting the world of political economy in the period after August 1971. The balance-of-payments issue, that stalwart of the 1960s, remained ripe as always for analysis and discussion. By arrangement among the major nations at a meeting at the Smithsonian Institution in Washington in December 1971, currencies would retain fixed rates to each other against a lower dollar par. The fixity definition became wider as well. The goal was for currencies not to trade far beyond a 2-percent band against the dollar. Gold got a new increased official value, $38 per ounce, which was a dead letter in that the United States was not selling. Wags called the result a “snake.” Currencies would slither along together in ever-­ progressive devaluation against the gold anchor. Whether it mattered that the United States still ran current-account deficits in this new environment was not clear. It was another fillip to more talk and paper-writing about currencies and the balance of payments.7 Laffer contributed his thoughts. In a 1972 article in another top place, the Journal of Money, Credit and Banking, Laffer wrote in his capacity as the OMB economist of his reflections on the payments developments. As usual, he found them unremarkable. He noted the Walrasian identity that if n−1 markets are in equilibrium, then n markets are as well. It was a point he had been making now for years. If the goods and services and capital markets were in equilibrium—which is their natural course—then the currency market was as well. He noted that the American current-account position had appeared to improve in late 1969 and early 1970, before deteriorating in 1971. It was a reflection of the recession and recovery. As American growth ebbed, American purchases including of imported goods slowed, leading to less dollar flows abroad. The higher comparative rate of growth abroad also promoted American exports over imports and therefore additional relative foreign demand for the dollar. Laffer emphasized “foreign minus U.S. growth” as the main determinant. The higher that number, the more “improvement” in the American current account, and vice versa. Laffer reiterated his views on international financial intermediation, noting that his Brookings presentation on the topic was soon coming out in conference proceedings. “The role of the U.S. as the world’s banker has tended to reduce the recorded U.S. trade surplus,” he wrote. The dollars that foreigners continued to prefer as their reserve asset required not making purchases of American goods. This reduced any American trade



surplus or turned a surplus into deficit. American recession would blunt this effect, in that recession meant a decline in production and income, and with this the comparative decline of import and export goods. The thesis of Mundell’s “Growth and the Balance of Payments” held. Alternatively, with growth came the filling out of asset classes that could populate wealth and currency-reserve portfolios the world over (and with recession, the attenuation of these effects). “There is little evidence to suggest that new factors are at work in determining the balance of payments,” Laffer found once again. He added a mysterious, and possibly mordant, observation to close. “To the extent the United States continues its dual role of net asset holder and producer of money, we should expect less of an improvement in the current account surplus. To the extent either of these roles is curtailed, we should expect a long-term improvement of the current account.” The way out of the balance-of-payments problem, which the field of international macroeconomics and policymaking had labeled chronic, was long-term American stagnation. Laffer was entertaining this outcome as a possibility in early 1972.8 That spring, Nixon asked Shultz to replace John Connally as secretary of the treasury. Shultz accepted and was replaced as head of OMB by Caspar Weinberger. Laffer’s second year of leave was up at Chicago. He had to return to the university to maintain his tenure. Chicago’s academic year began late, in October, and Laffer took the opportunity for a short position at Texas Tech University. A dean at Stanford Business School had fielded a request from Texas Tech about whether Laffer would be interested in teaching there. When Laffer realized he could spend time with the renowned turtle expert at the university, Francis Rose, he accepted the appointment for late summer. Laffer’s major avocation since his Cleveland upbringing, among his parents’ Airedale Terrier kennel and the rose garden, concerned flora and fauna. Laffer was building collections of fossils, animals, plants, and trees, the latter in particular after 1976 when he lived on expansive properties in Southern California. He spent the three weeks at Texas Tech, on the side exploring with Rose the wildlife magnets, such as South Padre Island, of the south Texas coast. One of his fellow faculty members was Kent Hance, who as a member of the House of Representatives from 1979–85 was a central “Boll Weevil” Democrat advancing the economic legislative agenda of President Reagan, in particular the 1981 tax-­ cut bill which bore his name as a sponsor. The stop at Texas Tech indicated, probably, a dread Laffer harbored about returning to the University of Chicago after his two years’ leave at



OMB. When he came back to his associate professorship in October 1972, he found the environment among the faculty horrendously chilly. Stigler, who had championed his early tenure three years before, was greatly displeased about the matter of the doctorate and was not affable toward Laffer. Those in the Stigler aegis who preferred not to be at odds with the leader shunned the returning associate professor, now with Ph.D. in hand. There were faculty, including Friedman and Arnold Harberger, who remained cordial and sincerely friendly with Laffer, but his boon companion Mundell was gone. Laffer found he had to pay for his phone calls and photocopying. He began casting around for other places to work. In the fall of 1973, he went on another leave, to the University of Virginia. A detailed letter of Laffer’s the next year to the economics department chair at Virginia, Richard Selden, appealing for a permanent job gave a sense of Laffer’s desperation. It summed up, “Dick I hope I haven’t come on too strong….I like to think it is the attractiveness of U.Va.”—rather than his current depressing position—that was responsible for his keenness to split from Chicago.9 Laffer found camaraderie among his students. He regularly taught business courses in such areas as money and banking, pure trade, and macroeconomics and became a regular on the intramural speaking circuit at the university. Conservative groups identified him as one of their own, presumably because of his service under Nixon. He spoke, on economic policy alternatives, to such groups as the Club for Responsible Individualists and the campus libertarians. He was the faculty member on the committee allocating money to student organizations. His activity with the students brought him in for ribbing and affection. In a student announcement of an upcoming talk of Laffer’s on the method of “least squares” (which Laffer and Ranson had called on in their OMB model), the campus paper called the dear professor the “most square.” Laffer was also one “of our favorite faculty members,” as a group welcoming new students put it in an advertisement for get-togethers with select convivial professors. One of the stops on student-run tours of curious spots on and around campus was Laffer’s home—to see the turtles.10 Laffer did make a good new friend on the faculty. This was Fischer Black, who had joined the Graduate School of Business as a visiting professor, soon full, while Laffer was at OMB. The two hit it off, almost unbearably, in that they enjoyed acting boyishly together, snickering in the back of a hall while a visitor gave a serious lecture. Black was a financial mathematics prodigy who after gaining his Harvard Ph.D. had tried to ply



his trade in business. He found that uncongenial and decided for academia. Chicago scooped him up, setting a pattern. MIT tenured Black into a named professorship out of Chicago four years later, and a decade after that Goldman Sachs recruited him back into business. Black wrote disarmingly simple articles in major finance journals that fairly annihilated a received view with unornamented symbolic logic. On arriving at Chicago, one of his targets was the exogenous character of the money supply. Black’s math indicated that it was impossible not to profit from exogenous characteristics of the money supply. Unless there were some mass arbitrage failure in the markets, an economy creates money endogenously. If there were lags, there was money to be made on the knowledge. Milton Friedman was cool to the idea. As Perry Mehrling recounts in his biography of Black, Friedman had Black present his views in the money workshop in early 1972, the spring prior to Laffer’s return: Into the lion’s den went Fischer….[Business professor] Jim Lorie recalls, “It was like an infidel going to St. Peter’s and announcing that all this stuff about Jesus was wrong.” Friedman led off the discussion: “Fischer Black will be presenting his paper today on money in a two-sector model. We all know that the paper is wrong. We have two hours to work out why it is wrong.” And so it began. But after two hours of defending the indefensible, Fischer emerged bloodied but unbowed. As one participant remembers, the final score was Fischer Black 10, Monetary Workshop 0.

The paper that emerged from the workshop came out in the Journal of Finance in September as Laffer was returning to Chicago. As Black summed it up in that paper, “There is no way for the government to implement an active monetary policy that is consistent with continual equilibrium in the money and bond markets.” Here was Laffer’s point about Walrasian equilibrium. If two of three markets are in equilibrium, so is the third. “We have found,” Black went on, “that passive monetary policy is always consistent with stability in this model and requires no sacrifice of its equilibrium properties.” And in the point that attracted the likes of Goldman Sachs, “If individuals and firms knew the properties of these [exogenous] models and acted to maximize utility and profits, then the models would stop being valid.”11 A young Fischer Black interested in the embeddedness of money in the market and prone to eupeptic juvenile behavior was what Laffer needed in a new friend on his return to Chicago in the fall of 1972. In developing his



monetary views, Black had clearly drawn, as Laffer had, from the work of Laffer’s Stanford professor, Edward Shaw, in particular Shaw’s inquiry into the notable, if not predominant role that inside money (of which trade credit was an example) played in the formation of the money supply. That fall, Laffer and Black discussed a paper Black was writing on the “uniqueness of the price level,” as in its title, in exogenous money-supply models. Black was incredulous that active monetary policy could be shown to lead to a unique path toward a change in the price level. Yet intuitively he felt that outcomes among rational actors trace unique paths. Black worked out the math and discerned multiple paths. In particular, he derived from exogenous money-supply models a “second-order, linear, difference equation” about future changes in the price level and said about it, the “standard method for solving such an equation is to look for two solutions” of a certain form. “The general solution will be a linear combination of these two specific solutions.” Such a linear combination was analogous to the Laffer curve, which is a continuous series of two tax rates yielding the same revenue. It emerged in Laffer’s notes in 1974, when Black’s article was published.12 In a certain sense, Black replaced Eugene Fama as Laffer’s youthful compatriot and sparring partner on the Graduate School of Business faculty. The three were born within two years of each other (1938–40) and represented a new generation that would translate ideas about predictable paths and monetary endogeneity (such as Shaw’s) into an idiom appropriate to the world as it developed in the active-monetary-policy and currency-­trading context of the 1970s and beyond. This is not to mention the immense use to which their MBA and doctoral students, such as Rex Sinquefield, David Booth, and Robert G. Ibbotson, put their insights in the development of index funds in the investment marketplace. While Laffer was at OMB, Fama finished work the two had been doing jointly and suggested to Laffer that given their geographic separation, Fama would prefer to work alone or perhaps with resident faculty collaborators. The first to the office in the morning, Fama needed someone enthusiastic about coming in every day—this Laffer could no longer be at the University of Chicago. A final article of Fama and Laffer’s appeared in the AER in 1972, with the two following up with a comment on the criticism in the same journal two years later. The article concerned “The Number of Firms and Competition.” It strove to vindicate, once again, the idea that regulation is rarely called for even in the case of near monopolies. As they wrote, “the major result of [their] general equilibrium analysis is the



following: under certain conditions, a general equilibrium with two or more noncolluding firms per industry is perfectly competitive.”13

Debut at the Journal At some point early in the year in 1969, University of Chicago MBA candidate Judy Thornber was raving to her husband, E. Hodson Thornber, a recent economics Ph.D. from the university with ties to the investment community, about her professor Arthur Laffer. That he knew a great deal about what was going on in the economy must have been the gist of the message. Hodson Thornber brought this information to the attention of two young managers, Charles Parker and David Richards, at the New York investment firm H.C. Wainwright, which trolled its contacts for tips on knowledgeable new economists. Parker and Richards sought Laffer out, met with him, and in the summer of 1969 signed him to an advisory contract with the firm. He would be paid a quarterly stipend to write occasional pieces for the firm and to consult with its principals and clients. Laffer did this initially for a year. It was the germ of his proprietary economic consultancy that has been his chief institutional affiliation since his resignation from his professorship at the University of Southern California in 1984. In 1970, he and Wainwright agreed that they had to suspend their arrangement while he occupied his government position with OMB. On his return to Chicago, Laffer started up with Wainwright again. There was plenty to talk about. The demise of gold and fixed rates made for an uncertain investment environment—but one in which, as Black noted, there could be acute arbitrage opportunities. During the 1065 episode, one of the innumerable phone calls Laffer fielded was from Jude Wanniski, a reporter for the National Observer, a weekly Dow Jones newspaper. By Wanniski’s own admission, he “knew nothing about economics,” but called Laffer because his name had been so in the news care of 1065. Laffer got together for a quick lunch with Wanniski at an eatery steps away from Laffer’s office at the White House. That first meeting turned out to be an extended one and followed up by a great many more. Wanniski found himself fascinated by the economics Laffer described in mini-lectures, probably not terribly different from the ones he was periodically giving Shultz. Wanniski continued writing on his standard political-beat themes but was preparing a move into economic commentary. The next year, Robert L. Bartley, the new editorial-­ page editor of the flagship Dow Jones publication, the Wall Street Journal,



asked Wanniski to join him on the page as his deputy. Wanniski accepted, saw an opportunity to break into the economics discussion, and introduced Laffer to Bartley.14 Bartley was no student of economics either. He had written widely for the Journal over the previous decade, distinguishing himself in articles on national-security policy and in book reviews. He found Laffer interesting, though by all accounts for some years until a sort of conversion around 1976 he could not abide tax-rate cuts. This was consistent with the Eisenhower-era fiscal posture of the Journal, that there should be no tax cuts before spending cuts. Bartley asked Laffer to submit an opinion piece for the editorial page. Laffer obliged, and in January 1973 came Laffer’s first piece in the Journal, “Do Devaluations Really Help Trade?”15 It was a recapitulation, for the newspaper’s popular business audience, of the article he had published the year before in the Journal of Money, Credit and Banking. It made its affirmative points not by means of theory but evidence, a nod perhaps to the practical nature of the newspaper’s readership. Laffer’s thinking in this regard had first sprouted seven years before care of Mundell’s pointedly theoretical “Growth and the Balance of Payments.” That paper had dismissed the notion that devaluing countries improve their growth prospects. “No theory advanced in the postwar era has been more greatly in conflict with the facts,” as Mundell had written. “However, this appeal to facts is quite unnecessary, because the theory itself is inadequate and misleading.” With that, Mundell was off to his parallelograms. Laffer followed Mundell’s lead to begin his article before setting aside theoretical treatments in favor of the empirical record in this first piece of his, the first of dozens, that he would write for the Journal. In the future, as he gained a readership and a following in the paper, he increasingly advanced his arguments in a theoretical mode, lecturing, after a fashion, as he did on call to Shultz, Wanniski, and soon Bartley as well. “The popular theory behind the relationship between exchange rates and trade balances is straightforward,” Laffer wrote in the opening paragraphs of this article. This theory was that “by raising the dollar price of foreign exchange (devaluation of the dollar), the dollar cost of foreign goods will naturally rise [and] the foreign currency price of American export goods will now be lower.” As a result, “Americans will buy less of the now higher-priced foreign goods [and] American export goods should sell better abroad because of the decline in the price foreigners have to pay for them. The end result of a dollar devaluation should be an improvement in the overall U.S. trade balance (U.S. exports minus U.S. imports)….”



In a near quotation of Mundell, Laffer found that “nothing appears to be more at odds with the theory than the current trade balance picture of the U.S.” Laffer went into the evidence. He noted that since mid-1970s, the dollar had depreciated by over 10 percent against the currencies of major trading partners. Meanwhile, he noted, the US merchandise trade balance declined by $9 billion over the period of the dollar depreciation. He pointed out that other countries experienced moves in similar directions. When West Germany revalued (or raised the value of) its currency, its trade balance showed no deterioration. He then made the point that he had stressed in the academic journal: “trade balances…do appear to be quite closely related to differential growth rates.” Purchases of imports correlated to income. If the United States was growing well through early 1973 comparted to its major trading partners, which it was, it was sure to buy proportionately more from these partners than they would buy from it. In conclusion, in the spirit of “Growth and the Balance of Payments” and “An Anti-Traditional Theory,” he wrote, “I think the use of the trade balance as a policy indicator distinct from domestic growth has probably been overdone and should be played down….Much of the blame…for poor trade performance should properly be praise for bringing about rapid economic growth.” A week after this article came out in early February 1973, the United States devalued the dollar again. It raised the par price of the dollar from $38 to $42 per ounce of gold. The implication was that like in December 1971, those currencies fixed to the dollar should revalue their currencies by the proportionate amount, about another 10 percent, against the dollar. This time the major nations decided to bolt. Currencies thereafter were, in general, floating. The major examples of fixity that emerged topped out with the likes of the Hong Kong dollar. Shultz was the treasury secretary who officiated over this development. To be sure, he executed the wishes of Nixon, whose internal memoranda indicated that he was in no way sincere in his use of the word “temporary” in his announcement ending US gold redemptions on August 15, 1971. In the fall of 1972, Nixon and Shultz had both addressed the IMF in the interest of “international monetary reform,” as Nixon in fact put it before the group. Shultz made clear that there would be no room for gold and that fixed rates should be associated only with those regions (presumably including Europe) aspiring to a currency union. Newsweek reported that “for all Shultz’s [previous] endorsement of fixed rates…what he proposed would ensure almost enough flexibility of rates to satisfy his old mentor



and conservative guru Milton Friedman. And in fact Shultz’s protégé Arthur Laffer disclosed to Newsweek that Friedman had been consulted every step of the way in assembling the reform package.” On being apprised of this, Friedman replied that “Art Laffer unfortunately has the propensity to shoot his mouth off when he shouldn’t. And he should  not  have said what he said there.” Though Friedman conceded that there was an element of truth to what Laffer had said. Friedman had spent a day recently in Washington helping Shultz craft his IMF speech.16 In those same remarks—on an Instructional Dynamics tape—Friedman marveled at the change that had come over the international consensus on monetary affairs. He said, the fascinating thing has been that there has such been such a great meeting of minds all around. You have had…in the past few years a drastic change in attitudes….I almost fell over last spring at the international monetary conference in Montreal….I was almost bowled over when [the IMF director] got up and introduced a panel by saying of course, the first necessity is greater flexibility in exchange rates, a position that would have been utterly unheard of two years ago. Consequently, the newspaper comment has been right that what George Shultz’s talk at the IMF did was to bring together strands of ideas that have been developing and about which consensus has been forming.

Friedman went on to speculate that perhaps now instead of targeting currency prices (as in gold and fixed-rate standards), the international monetary system could strive to target quantities, specifically of foreignexchange reserves. Friedman was ascendant. As Nixon had said at the IMF, “I am convinced, on the basis of the evidence of the past year, that we are not only participating in a great moment of history but that we are witnessing and helping to create a profound movement in history.”17 In couching the matter in terms of “strands of ideas” and “a great meeting of minds all around,” let alone being “bowled over,” Friedman was perhaps encouraging the impression that a dedicated hit had not been in the works the whole while. This impression did take hold. As Robert Leeson wrote in 2003, in his chronicle of the intensive academic effort to end Bretton Woods in the period before 1971–73, “the role played by academic economists in this international revolution has usually been relegated to minor proportions or ignored altogether. Yet what appeared to be a sudden policy leap had been preceded by years of academic campaigning.” Leeson’s book is a month-by-month account from the mid-1960s on of the dedicated collective effort on the part of the easy majority of



luminaries in the field to get the goal. As Leeson argued, “academic economists believed ‘as if’ they were members of a coordinated coalition pressing for flexible exchange rates.”18 In 1968, as he reflected on the collapse of the Gold Pool, Mundell found that French actions attacking the pound and then the dollar, which led to the untenability of the pool, did not represent a harbinger of some nascent new consensus. The matter was not one of innocuous “strands of ideas.” Rather, in Mundell’s interpretation, the French perceived with Tocquevillian dread the coming of a dollar-determined foreign-exchange system, a non-system in which currencies would float in tune with the dollar, or else be wildly under- or overvalued against the inflating world price level. In a fruitless set of actions, France tried to stave off this eventuality by a gambit to replace the gold-exchange standard with a gold standard. Friedman’s tracing the developments since 1968 in terms of “strands of ideas…about which consensus was forming” added a patina of intellectualism and rationality where perhaps the ascription of more base and primal motivations was warranted. The United States was a hegemon prone to cluelessness (Nixon on tape: “I don’t give a [expletive deleted] about the lira”), the rather random creation of Fort Knox four decades before had convinced it of the need for a massive national gold stock, and currency-­ trading boomed at the expense of other economic sectors as the monetary system devolved into vainly searching for definition for the long term. That there were journals, conferences, and officials that had laid out the way to the eventuality of floating rates was interesting but beside the point. They came.19 Because Laffer and Mundell had never thrown in with the professionalist consensus for floating—and Friedman could have noted that the development of consensuses can be self-fulfilling, in that narrow self-interest prompts individuals into adopting a rising majority view—they risked marginalization. They were heedless about minimizing the chance of being called a crank. Each of them was, Laffer through his gaining of the Presidential Medal of Freedom in 2019. After exchange rates definitively floated in February 1973, what did not crank up was the American economy. The second quarter of 1973 now stands, in the longue durée of American macroeconomic history, as the final apex and terminal point of the vaunted post-World War II prosperity. GDP peaked that quarter. Generation-long growth rates pushing 4 percent in the United States have never been seen again.20



It was a fiction to begin with that GDP, or real income, peaked in mid-1973. The price controls of the previous two years had seen to that. Whatever total production there was, producers held a segment of it in reserve for when prices at last released. Investment in oil production or delivery equipment, for example, paid for in 1971–73, would have seen best return if the capital goods waited to be put to use until January 1974, when no matter any controls a barrel of petroleum had suddenly gone from $3.60 to $10. As for toilet paper, it keeps. Best to make it in the wage-price control era, hold it in inventory, and then sell it when the controls break and the inflation hits. The GDP run after the second quarter of 1973 was, however, reliable as a barometer. It was remarkably brutal. Over the seven quarters after June 1973, five saw GDP shrink. It was a big double-dip recession. Economic output at its trough in the winter of 1975 was nearly 3 percent lower than the 1973 peak. In a remarkable development, inflation surged as well. From June 1973 through March 1975, the twenty-one months encompassing the GDP declines, inflation rose at a 10 percent annual rate. As the number of unemployed grew by four million, nearly a doubling, the jobless encountered the unbelievable phenomenon of soaring prices— as if the consumer was mercilessly buying. It was an unusually disorienting, and for those who struggled with making ends meet and keeping productive work, a harrowing time. The term “stagflation” came in from obscure British usage to describe what had set in. Wanniski worked Laffer for insight into what was going on. Laffer’s next piece in the Journal came in January 1974, one of the rare full years in American economic history the entirety of which was spent in recession, per the NBER (the only other since 1932 was 2008). In keeping with the spirit of the times, this was called “The Bitter Fruits of Devaluation.” Johnny Carson chuckled at the “housewife” desperate given the toilet-­ paper shortage (“forget the coffee,” she told Mrs. Olson with the Folgers, “just give me the shopping bag”). Laffer had this archetype in mind too. As he began his opinion piece, “Inflation is plaguing not only the housewife but  also the economics profession….Conventional economic views did not predict and cannot explain increases” of the magnitudes just seen, on the order of 9 percent—and which would hold for over a year. He pointed out that the money supply was moderate, the budget deficit shrinking, and unemployment increasing. Nor, he noted, were there shortages in the international economy (toilet paper perhaps excepted).



Yet the American inflation rate exceeded that of its major partners by about a factor of four.21 He explained that conventionally, when it devalues its currency by 10 percent, a country such as the United States that imports about 5 percent of its GDP is supposed to see inflation of 0.5 percent. The 5 percent of exports goes up by 10 percent in price. This theory, he said, defied the reality of an “efficient market”—he used the term—in which each good in a market has a relative price to every other good. If imported goods change their price, all other prices will change to reformulate the relative price structure accordingly. By way of example, he wrote that “if any country produces goods that it both trades and consumes domestically, then items sold for domestic consumption will not differ in price from items sold for foreign consumption. Likewise, foreign imports into any country should also sell at the same price as domestically produced import substitutes— both before and after a devaluation. If these prices did not adjust,” he continued in the Fischer Black vein, “speculators could make virtually unlimited profits by purchasing goods in one country and selling them in another country.” Looking at that data including the various European devaluations of the late 1960s, he suggested that devaluations lead to overall domestic price increases in the devaluing country about as big as the devaluation itself in percentage terms. He pointed out that the evidence was consistent as well in the case of currency revaluations. To conclude he wrote to vindicate his now two pieces within a year on the Journal opinion page: “it would seem that a robust turnaround in the trade balance did not come until the rate of economic growth slowed, but that robust inflation took off as soon as devaluation took place.” In an unusual move, Bartley inserted an aside in the middle of Laffer’s piece. It read, “[Immediately after the February devaluation, indeed, the author predicted privately to an editor of this newspaper that the chief consequence would be ‘runaway inflation in the United States.’—Ed.]”

The Slutsky Effect The first piece Laffer wrote for the Journal, “Do Devaluations Really Help Trade,” was a digest of his “Monetary Policy and the Balance of Payments” article of the year before in the Journal of Money, Credit and Banking. In a similar vein, “The Bitter Fruits of Devaluation” anticipated his next journal publication, “Balance of Payments and Exchange Rate Systems,”



which came out in the Financial Analysts Journal that summer. The economics journals had proven cool to Laffer since his return to academic life after OMB and the Ph.D. controversy, but Black had gotten him plugged in to the organs of finance scholarship. Laffer’s article would win one of that journal’s best-article Graham & Dodd “Scroll” awards the next year.22 Laffer credited Black in the acknowledgments (along with Mundell and Ranson and two others). The article bears his impress. It reads like one of Black’s articles. There are relentless discrete observations, all prose (as could be found in the Black oeuvre), which make the conventional wisdom appear absurd. The first point concerned the terms of trade. Quoting Friedman as a representative of the conventional view, Laffer noted that a devaluation is supposed to change the terms of trade, “the price of exports divided by the price of imports,” by decreasing the former and increasing the latter. He reiterated the point he had made in the Journal that a 10 percent currency devaluation should bring a one-time 0.5 percent inflation in a country like the United States importing 5 percent of its GDP. He countered that “it is hard to refute the proposition that changes in exchange rates are fully offset by relative rates of inflation within a fairly short time period. It appears that if a country devalues its exchange rate by about ten percent, over some period of time, its cumulative inflation will exceed the rest of the world’s inflation by about ten percent. This inflation effect offsets any changes in the terms of trade brought about by a change in exchange rates.” He cited empirical work by his student Moon Hoe Lee showing that “any single country’s expected inflation rate is approximately equal to the U.S. rate of inflation plus the rate of depreciation of that country’s currency vis-à-vis the U.S. dollar.” Black had seen this work of Lee’s and marveled to Laffer at it, how the pattern held “between the U.S. and every other country!”23 The mechanism, as Laffer had described it in the Journal, involved the recalibration of all relative prices in a country’s economy after the change in its import and export prices care of the devaluation. Without mentioning the income-effect/substitution-effect equation of Eugen Slutsky explicitly in the Financial Analysts article, Laffer implied that he was thinking along its lines. A disturbance in relative prices from a status quo will call forth a range of connected income and substitution effects—the Slutsky-equation process. On the income side, an increase in the prices of imports means less real income and therefore less purchases of all goods, not just the imported ones, on account of the diminished buying power. The increase in the prices of imports, in turn, occasions a substitution



effect, namely substitution into other goods that become comparable to the imported goods along a schedule of a price-quality tradeoff. The reverse happens with respect to exported goods. The comprehensive result is a new configuration of relative prices across the entire economy—even if trade accounts for only 5 or 10 percent of national economic output. Laffer went on to criticize the conventional view for improperly relying on “importable demand functions.” Just as reasonably, he proposed, one could call on “exportable demand functions.” In the latter case, Laffer wrote in counter-intuitive glory, “if a country devalues, its export good falls in price relative to its import good. Under normal demand and supply conditions, the residents should buy more of the export good and produce less of it. Therefore, exports of the devaluing country should fall. Likewise, abroad, foreigners should buy less of their export good and produce more, making for larger imports by the devaluing country. The trade balance therefore worsens in real terms when a country devalues.” Laffer remembers conversing at the time with a high monetarist, probably Allan Meltzer, who found this argument unanswerable. The next point Laffer made concerned nominal interest rates. In fixed-­ rate circumstances, the typical commonality of the inflation rate across the connected countries required little to no arbitrage for nominal interest rates to equilibrate globally. Not so for floating rates. As Laffer wrote, “as long as the real cost of holding money—the nominal rate of interest—is allowed to differ among countries, then we must have a suboptimal distribution of real money balances. Inequality of real money balance costs will tend to distort production and consumption decisions. Money intensive production processes will tend to go to the country with lower rates of inflation and vice versa. A more efficient solution in our specific example would be for each country to have the same percentage rate of inflation and thus allow money balances to be arbitraged efficiently between the two countries.” To complete the point: “Efficient arbitrage is the natural result if the two countries have a common currency or rigidly fixed exchange rates.” To close, Laffer offered a proposal. He strove to show that instituting fixed rates could be done quickly, easily, and successfully. To date, Laffer’s academic articles had defended the status quo of fixed rates. They carried no burden of outlining a monetary system different from the one currently prevailing. After 1973, Laffer no longer had this luxury. He had to make his case for reform as opposed to preservation of existing arrangements. In this article, Laffer offered the example of “ceiling support,” in



which two nations agree to buy the other’s currency in their own currency so as to fix the rate between the two. In the example he gave, the United States has “unlimited” resources to by the British pound in dollars, because it can create dollars. Likewise Great Britain has an unlimited ability to buy dollars in pounds. Because of these capabilities, the two countries can decide together to guarantee the lower bound of each other’s currency and therefore, effectively, fix the dollar-pound exchange rate. This arrangement is “impregnable to attack” by speculators, because both countries can create their own currency for the intervention purpose at will. “It is surely possible to devise a workable fixed exchange-rate system,” Laffer wrote, appealing for reform as circumstances required him to in 1974. Laffer’s complementary articles of 1974 in the Wall Street Journal and the Financial Analysts Journal offered, on inspection, the beginnings of a complete theory of the stagflation then putting its grip on the American, and to a good degree the world economy. The devolution from fixed to flexible rates over the previous several years had in the first place sprouted domestic inflation in the disproportionately devaluing countries. In 1971 and 1973, the United States was the serial devaluer, and in turn came rates of American consumer price increases totaling something comparable to the degree of the devaluation against the currencies of the major trading partners. Here was the account of inflation. In addition, Laffer proposed that flexible rates reallocated investment capital toward arbitrage responsibilities that did not have to be attended to in the fixed-rate regime. The result of the arbitrage was the recalibration of the relative price structure, which needed no retrofitting under fixed rates. Lurking in this phenomenon was a deadweight loss, a dedication of capital toward fundamentally non-productive purposes. The crude expression, perhaps, was the march of the currency-trading business as a share of the economy, displacing everything else inclusive of the range of useful goods and services. Strictly within changes in the monetary regime, Laffer detected the causes of the stagflation phenomenon. He was confident that his account of inflation as a direct expression of devaluation was statistically and empirically valid. The matter of the loss to real growth, however, remained a speculative matter. Provisionally, it appeared to be large, in that the attention and resources dedicated to the Slutsky income-substitution changes were necessarily economy-wide. Yet the ultimate loss to efficiency and growth remained to some notable degree obscure. In his field-defining articles of the early 1960s, Mundell had called on Jan Tinbergen’s theory of “effective market classification,” which Mundell



cast in italics in 1960 as respect for the following proposition: “a system works best if variables respond to the markets on which they exert the most direct influence.” In 1962–63, in his work for the IMF, Mundell clarified that under fixed exchange rate systems, fiscal policy is the best target for the real economy and monetary policy for the balance of payments. In “The Dollar and the Policy Mix: 1971,” Mundell specifically urged that in current conditions of inflation and a run on the dollar in the context of recession, the effective-market-classification optimal “policy mix”—the term in the title—was “monetary restraint” to address the inflation and the currency in concert with “fiscal ease” to spur real growth. By implication, the reverse, monetary expansion and fiscal restraint had caused the problem to begin with.24 In the economics Laffer had published as of 1974, monetary measures and systems were the determinants of his models. As of the piece in the Financial Analysts Journal, he had shown that departure from organic, time-honored monetary principles such as gold and fixed rates occasioned not only inflation but suggested clues about the other element of stagflation, limited or negative growth. From a methodological perspective, however, and perhaps at Mundell’s urging, he may have wondered if his account needed to reach for a greater fullness. He was a student of the monetary regime. Explaining everything in terms of the monetary regime ran the risk of partaking in a fallacy of explanation, such as the fallacy of limited scope in which the causes of all phenomena under investigation are determined to issue from one source. Stagflation was a sufficiently severe problem to warrant probing questions of this sort. In terms of fiscal policy, Laffer had his “Formal Model of the Economy,” complete with its fiscal variables, constructed with Ranson. In the hubbub surrounding this model’s application to the administration’s forecast numbers, a curiosity of its results went unremarked upon—though careful readers of the model’s publication in the Journal of Business in the summer of 1971 could have discerned it. This was that transfer payments in one quarter led to GNP declines in future quarters. The result was confounding enough for Laffer and Ranson to pass over it in the continual commentaries they were called on to make about the model in 1971. Nonetheless the matter stuck in their minds. They pursued some leads, and their further study yielded a result in an extended paper on the social security system the two presented to the National Tax Association in 1973. They went over many ways they felt social security conduced to economic



inefficiency, in particular doing so “with respect to the nominal contribution of the employee,” and “also with respect to that of the employer.” The payroll social-security tax, falling directly on both employee and employer, “introduces a discrepancy between compensation paid and compensation received. This ‘wedge’ has to be borne for additional labor employed, but not for other factors such as machines. Firms therefore have an economic incentive to substitute equipment or other factors of production for labor, and workers have an incentive to reduce labor input. If the labor market is initially in equilibrium, then workers will receive a lower wage and employers will pay a higher one. Moreover (unless labor supply is wage-insensitive or backward bending), labor input will decline as well. The rents or prices and utilization rates of other factors of production (equipment, land, power, raw materials, etc.) will be raised since the demand for these factors has increased.”25 Laffer and Ranson were in the vicinity of the Slutsky equation here as well. A new cost—the social security tax “wedge”—disturbed the whole gamut of decisions in the economy about, on the employer side, whom to employ and at what rates and hours, as opposed to seeking out further uses for and innovation in capital goods, and on the worker side, how to split the work/leisure tradeoff. The arbitrage necessary to retrofit the relative preference schedule after the imposition of a social security tax wedge must be forbiddingly large, and affecting every cranny of the economy. This was not even to mention the income effect—of percentage points of wages paid sailing off from the employer to the government, not to be seen pre-retirement (excepting in certain minor cases) by the employee. Laffer and Ranson, in their Slutsky-like musings over the wedge, were developing the outlines of a tax model of the economy. In his monetary papers through 1970, Mundell had shown in his geometry that suspensions in real growth occasion declines in the demand for real money balances, jeopardizing in particular gold-standard systems that required that there not be chronic immoderate demand for gold itself. The necessity in his monetary economics was that domestic growth be robust. In such a condition, the received monetary system, inclusive of fixed rates in particular but gold as well, could function to its natural expansive fullness. The somewhat unstated key in their respective classic papers, Mundell’s “Growth and the Balance of Payments” dating from 1966 and Laffer’s “An Anti-Traditional Theory” of 1968 was domestic growth spontaneously arrived at. As of the unmistakable onset of a forbidding stagflation after the small bout of 1969–70 that had prompted



Mundell’s fulminations in “The Dollar and the Policy Mix: 1971,” in 1974 Laffer and Mundell dropped all hesitancy and required to know the tax as well as the monetary roots of the current crisis.

Notes 1. New Approach to United States International Economic Policy, 8–9. 2. Harold James, review of Gold, Dollars, and Power by Francis J.  Gavin, Journal of Economic History 64, no. 2 (June 2004), 630–31. 3. New Approach to United States International Economic Policy, 8. 4. Commenting on the application of Bourdieu’s field theory to intellectual history, Fritz Ringer wrote in 1990: “The elements in the field are not only related to each other in determinate ways; each also has a specific ‘weight’ or authority, so that the field is a distribution of power as well. The agents in the field….compete for the right to define or to co-define what shall count as intellectually established and culturally legitimate. The participants in the field may be individuals; or they may be small groups, ‘schools,’ or even academic disciplines.” Ringer, “The Intellectual Field, Intellectual History, and the Sociology of Knowledge,” Theory and Society 19, no. 3 (June 1990), 270. 5. See the literature review here in Chap. 1. 6. “Johnny Carson Jokes About the Recent Toilet Paper Shortage—12/19/1973,”­Lz0SbrA. 7. Barry Eichengreen, Globalizing Capital: A History of the International Monetary System (Princeton: Princeton University Press, 2008), 149. 8. Arthur B. Laffer, “Monetary Policy and the Balance of Payments,” Journal of Money, Credit and Banking 4, no. 1, part 1 (Feb. 1972), 13–22. 9. Laffer to Richard Selden, n.d. (circa 1974), Chicago file, Laffer archive. 10. Chicago Maroon, Feb. 20, 1973, p.  2; June 21, 1973, p.  8; Sept. 27, 1974, p. 9. 11. Perry Mehrling, Fischer Black and the Revolutionary Idea of Finance (Hoboken, N.J.: John Wiley & Sons, 2005), 159; Fischer Black, “Active and Passive Monetary Policy in a Neoclassical Model,” Journal of Finance 27, no. 4 (Sept. 1972), 813. 12. Fischer Black, “Uniqueness of the Price Level in Monetary Growth Models with Rational Expectations,” Journal of Economic Theory 7 (January 1974), 53, 59. 13. Eugene F.  Fama and Arthur B.  Laffer, “The Number of Firms and Competition,” American Economic Review 62, no. 4 (Sept. 1972), 670.



14. Jude Wanniski, “Why Nixon Left Gold,” Jan. 8, 1999, 15. Arthur B.  Laffer, “Do Devaluations Really Help Trade?” WSJ, Feb. 5, 1973. 16. “I believe that it is essential that there be no further speculation within the Administration…with regard to…a return to some form of convertibility. Our planning at this time should proceed on the assumption that we are not going to move in that direction.” Memorandum, Nixon to John Connally et al., Nov. 2, 1971, “Presidential Meetings—Quadriad—1970” folder, “Meetings Files: Presidential Meetings” file, McCracken papers; addresses by Nixon and Shultz to the IMF, Annual Report of the Secretary of the Treasury on the State of the Finances: For the Fiscal Year Ended June 30, 1973 (GPO, 1973), 397–404. 17. Milton Friedman, “International Monetary Fund,” Oct. 5, 1972 (sound recording), Economics Cassette Series, Milton Friedman papers, Hoover Institution, Stanford, Calif.; Nixon, IMF Address, 397. 18. Leeson, Ideology and the International Economy, 1–2. 19. “Transcript of a Recording of a Meeting Between the President and H.R. Haldeman in the Oval Office from 10:04 to 11:39 a.m.,” June 23, 1972, RNPL. 20. Jonathan Chait, “Trump Awards Kook Art Laffer for Inventing Fake Curve,” June 19, 2019,; David Warsh, “Mundell Comes in From Cold With Nobel Prize,” Chicago Tribune, Dec. 12, 1999. 21. “Johnny Carson Jokes About the Recent Toilet Paper Shortage;” Arthur B. Laffer, “The Bitter Fruits of Devaluation,” WSJ, Jan. 10, 1974. 22. Arthur B.  Laffer, “Balance of Payments and Exchange Rate Systems,” Financial Analysts Journal 30, no. 4 (Jul.-Aug. 1974), 26–32, 76–82; “FAF Newsletter,” Financial Analysts Journal 31, no. 4 (Jul.–Aug. 1975), 79. 23. Black to Laffer, Oct. 15, 1973, Chicago file, Laffer archive. 24. Robert A. Mundell, “The Monetary Dynamics of International Adjustment under Fixed and Flexible Exchange Rates,” QJE 74, no. 2 (May 1960), 250; “The Dollar and the Policy Mix,” 24. 25. Arthur B. Laffer and R. David Ranson, “Some Economic Consequences of the U.S. Social Security System,” Proceedings of the Annual Conference on Taxation Held under the Auspices of the National Tax Association—Tax Institute of America 66 (1973), 224.


The Laffer Curve

In June 1974, on the editorial page of the Wall Street Journal, Jude Wanniski found some reason to express relief. Of all the problems the nation was facing, they no longer included a looming cataclysm concerning the balance of payments. Ever since Robert Triffin had testified to Congress in 1959, the accumulating chance that the United States might run out of gold, because of fixed exchange rates and the deficits it ran in the net trade in currencies, had been a public-policy problem du jour. Now that was all over with. As Wanniski put it in the Journal: “When economic policymakers get together in Washington they fret that the usual economic medicine no longer seems to work—inflation seems oblivious to fiscal discipline, tighter money, dampened demand or increased supply, or even new proposals to tie the economy to the consumer price index. But at least, the policymakers sigh, our international problems have been solved by floating exchange rates.”1 It was too true. With the dollar free to float after February 1973—sixteen months before Wanniski wrote this column—and any claim on the US gold stock null and void, the whole Triffin-ite problematic of how to maintain equilibrium under the gold-dollar-bound Bretton Woods system became a care of the past. No foreign country could claim US gold. If dollars went abroad disproportionately, there was no further settlement implication beyond the trade that had brought them there in the first place. If foreign countries did not prefer the dollar’s being oversupplied or © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 B. Domitrovic, The Emergence of Arthur Laffer, Archival Insights into the Evolution of Economics,




the American inflation couriered by the dollar, the markets could devalue the dollar to offset the effects. The great international monetary problem of the 1960s had found its solution in the 1970s. Yet as Mundell had said in Congressional testimony in 1965: The most exceptional characteristic of the world economy in the past 15 years is its unparalleled prosperity and stability. I can think of no comparable period in the whole of modern history, excepting neither the prosperous years of the gold standard nor the relative prosperity of the years preceding the French Revolution. During this period the dollar standard, or the gold-dollar exchange standard, or the gold-dollar-sterling exchange standard—however we want to characterize it—has served the needs of prosperity and trade admirably. Although it is not beyond the ingenuity of economists to invent a more elegant system, the one we have has worked much better than its reputation and would suffice for the future provided it worked no worse than it has in the past. Who would complain if the world economy in the next 15 years were as prosperous as the last 15?

The advocates of the balance-of-payments crisis, that is who—Robert A. Mundell should have known this in 1965. The prosperity of the world economy of 1950–65 came with a collateral effect that just had to go, the balance-of-payments crisis. The issue apparent as of 1974 (to Wanniski at least) was that the one problem, the balance-of-payments one, was traded out for a big set of real problems, of the inflation and unemployment variety, and the inflation was far greater than regularly seen in peacetime.2 Generally that there was such a trade-off is not acknowledged. The conventional view in scholarship and opinion—or perhaps the “popKeynesian consensus” in Bartley’s words—is that an exogenous development, the oil shock of 1973–74, threw the world economy into stagflation. There are also arguments about waning American productivity in the early 1970s contributing to cost-push inflation and layoffs; about the new competitiveness of the rapidly developing countries, and West Germany and Japan, rendering American products comparatively expensive and those who produced them prone to get the sack; and about the effects of the mismanagement of the budget during the Vietnam war, President Johnson’s vacillation in not raising taxes in 1967 touching off the long season of inflation—the arguments run. To be sure, there was no consensus then, in the mid-1970s, nor is there now, that the cashiering of Bretton Woods was the key that unlocked the cage holding back stagflation. But it



was Laffer and Mundell’s argument. And now both of these economists had Jude Wanniski’s ear.3 Wanniski was right about all the things that were not causing the big inflation. As of June 1974, when Wanniski wrote this piece, inflation was clocking an annual rate since the February 1973 float of 10 percent. By monetarist lights, money was tight. The money supply had been growing at a particularly small rate. From the time of the February 1973 devaluation through June 1974, M1 moved up at an annual rate under 5 percent. Paul McCracken would have looked at such a money-growth rate in 1970 and called for bold new plans. As for interest rates, they had been soaring. The federal-funds rate averaged over 10 percent—a shocking number four times greater than the average of the 1950s and at least double that of the 1960s—over the latter part of 1973. By June 1974 it was pushing 12 percent. Monetarist lags at their long and variable most inscrutable were supposed to kick in within no more than nine months. Here was unusually tight money in long preparation for double-digit inflation. As for fiscal discipline, the federal budget deficit was rapidly dwindling. It would come in for 1974 at merely $6 billion in the fiscal year ending the month of Wanniski’s column. This was down from the recent nominal peak of $25 billion in 1968 at the height of the Vietnam/Great Society expenditures (and despite a 10 percent income-tax surcharge enacted in that year). In nominal terms, the 1974 deficit was less than a quarter of the recent record. In real terms, thanks to the consumer-price increases totaling over 40 percent of the previous six years, the deficit was about a sixth of that of 1968—and well less than the deficits of 1971–73 which averaged a nominal $20 billion. The United States had been tightening its budget. And the tremendous inflation came. These monetary and fiscal data points were, effectively, in a phrase security-­studies-minded Bartley was fond of using in this context, “an Exocet [missile] aimed at the heart” of both the monetarist and Keynesian universes. A perhaps unintended effect of monetarist Allan Meltzer and Karl Brunner’s founding of the Shadow Open Market Committee (SOMC) in 1973 was to wash monetarism’s hands of the emerging problem—to provide monetarism with plausible deniability when the Great Inflation emerged. The very existence of the SOMC served to buttress the view that policy was not adhering to the principles of monetarism. As Meltzer later commented on the founding of the SOMC, “Our objective at the time and after was not just to complain about the results of policy actions. We wanted to show that better policy choices were available and



that inflation could be controlled at acceptable cost, if the Federal Reserve controlled money growth.” As Meltzer further recounted, “the SOMC’s first statement” of September 1973 “pointed to high interest rates, forecast rising unemployment, and urged that money growth be reduced gradually from the prevailing 6½% to about 5½% as the first of a series of steps to lower inflation. The statement considered, and rejected, alternatives such as…a very restrictive policy to end inflation within a year.” A scholarly review of the SOMC four decades later found that the SOMC had “articulated a policy that would have outperformed the policies actually implemented by the Federal Reserve during the Great Inflation era.”4 Money was tight by any measure for an extended period prior to the historic surge in inflation in 1974, but monetarism had the analysis right. Wanniski was impatient with this view. As for the “drag” of a tight federal budget, it was doing nothing to constrain inflation. Rather it correlated to inflation’s take-off. The Keynesian concept of the “Phillips curve,” as Samuelson and Robert Solow had codified it in the early 1960s, positing a trade-off between unemployment and inflationary pressures if not inflation itself, became nonsense in the context of 1974. Inflation was coming in at 11 percent as unemployment would peak the next year at 9 percent. It was during the 1973–75 stagflation-recession that a shorthand term from the early 1960s CEA became current. The “misery index,” combining the inflation and unemployment percentages represented as a whole number, hit a stratospheric 17 in 1974 and 20 in 1975. It had been at 6 in 1965.5 Wanniski also noted that even “dampened demand or increased supply” were doing nothing to block the inflation—which would surge another 13 percent through the end of 1975. Consumer spending was declining as a percentage of economic output as investment had been increasing. In the figures reported early in 1974, consumption’s share of GNP had dropped over the previous two years by 1.5 percent, as investment increased by seven-tenths of a percent and business inventories at a similar rate. There was less demand and a greater share of economic activity devoted to supply—as the staggering price increases took hold. The producers who had held out for the collapse of Nixon’s price controls and the coming of big price increases had won. The experience left both monetarism and Keynesianism ragged.6 But there was no balance-of-payments crisis. Fort Knox could keep its contents. Under Bretton Woods, the United States had been running “deficits without tears,” in the formulation of legendary de Gaulle advisor



Jacques Rueff. It could print dollars and get goods and services while foreign nations chose to house the dollars in their reserve accounts, much like the United States preferred to house its gold in its vaults and forts. Another way of saying the same thing, without the dolorous words “deficits” and “tears,” was the financial intermediation thesis of Despres and his associates. With stagflation, the United States switched the deficits for tears. First came deficits without tears, then came no deficits (at least none requiring gold settlement) and tears. There was no balance-of-payments crisis, but there was a scarifying new combination of soaring inflation and high unemployment.7 Wanniski’s column was a tutorial in the economics of Laffer and Mundell, the latter of whom Wanniski had just met at a conference organized by Laffer the previous month. It was called “The Case for Fixed Exchange Rates.” It was the first of a series of columns by Wanniski, signed and unsigned on the Journal opinion page, explaining, and touting, as he called it here, “the Mundell-Laffer Argument.” His first point was Laffer’s central one concerning the relative price structure. As Wanniski wrote, “an article’s real price—that is, its value relative to other articles rather than to national currencies—cannot be different in two nations with closely related economies. If it were, supplies of that article would simply flow from one nation to another until the real prices were equal.” Therefore “when one country devalues,” Wanniski continued, “prices as measured by the two currencies will adjust to compensate for the change; the nominal prices will change to maintain equal real prices. And from this seemingly simple proposition flow a number of unorthodox conclusions.” This was indeed the heart of the Laffer (and Mundell) argument. The efficient  market operations of an integrated world economy made it impossible for terms of trade to change in any meaningful way on account of a currency devaluation. If devaluation makes a country’s exports less expensive, as Laffer wrote that summer, at play is the “discredited theory of absolute advantage” whereby a country gains sustained productivity superiority in the goods it exports thanks to lowering the exchange rate. As early as 1960, Mundell had dismissed as the “money illusion” the proposition that a “community…will accept…changes in real income through adjustments in the rate of exchange.” When one country’s exports suddenly become cheaper care of devaluation in an integrated, trading world economy, the original price structure restores itself. In the devaluing country, this process necessarily involves a general increase in prices. If its exports suddenly become cheaper, and there is one world price for those



export goods, then all other prices in that domestic economy must rise to reflect that one world price. This efficient market effect was the mechanism by which the world economy processed one country’s devaluation into a general inflation within that country.8 Wanniski wrote that “these two professors operate from a monetarist economic viewpoint,” while distinguishing their contentions from those of Milton Friedman and the monetarist advocates of flexible rates. This served perhaps to muddy the issue. In “A Formal Model of the Economy,” let alone his work on the endogeneity of the money supply, Laffer (joined by Fischer Black) had staked his economics on the principle that the money supply is given by the degree of economic activity, not vice versa. The one allowance Laffer made for the exogenous nature of the money supply concerned flexible rates. In eliminating the ability, under fixed exchange rates, for the world’s currency producers to make up for unsatisfactory monetary policy by one currency issuer, flexible rates rendered the supply of money unnaturally monopolistic and hence inefficient. There was trade credit and so forth that could pick up some of the slack, but the reduction of currency-issuers to one in any economy—the effect of floating rates—was a step toward inefficiency. Wanniski picked up on this point and called on his journalistic talents of explanation to get it across. “The idea that a fixed system is a market system and a floating system a controlled one is the most difficult Mundell-­ Laffer concept to see,” as Wanniski wrote. “Its essence is that when rates float, the central bank of each country has a monopoly over its money supply; when rates are fixed, the citizens of the participant countries share in a common money pool with no interference by their respective governments.” He continued: “Under a float, the citizens of the United States…have to rely exclusively on the…Federal Reserve to produce the precise money supply to meet demand,” and the Fed is “always wrong in one direction or the other. If an excess is produced…, it cannot be exported for use by other countries. If a shortfall…, citizens cannot make up the difference by borrowing foreign currencies and converting it to dollars [at par].” To complete the point Laffer had made in 1970  in Madrid (and published the year before in the proceedings), “under a fixed-rate system, …the central banks…do not have to be precise in their production of money. If they produce too much, foreigners will borrow it…and convert it to local currencies [at par]. If the Fed produces too little…, money demanders here will borrow abroad and convert those foreign currencies to dollars [at par].” Wanniski concluded by elucidating another Laffer



point from the academic outlets, one Laffer would outline in his Financial Analysts Journal article that summer. This was that to get fixed rates, “governments would be obligated to sell unlimited quantities of their currency at the floor price.” As Laffer was putting it in his article, this would make the fixed rates “impregnable.”9 Wanniski’s column marked a transition in Laffer’s economics and economic-­policy advocacy. Laffer had been a public figure to a degree since 1971, and since his arrival at Brookings in 1967 he had striven to present his economics both in the journals and in the broad fora of conferences that his profession provided. He was a participant in the many gatherings of “Robert the Convener” and probably picked up the habit from Mundell of making his views widely disseminated within the profession and those connected to it in policy. Though Wanniski had been conversing with Laffer continually since 1971, neither Wanniski nor the authors of the Journal’s unsigned editorials had incorporated Laffer’s views into their own. Wanniski’s June 1974 column on fixed rates was the beginning of such a process. It would take hold—and very much admittedly, as Bartley’s memoir The Seven Fat Years (1992) made plain—over the next several years. The 1971–73 economic distemper had not had consequences sufficiently real for Laffer’s views to be urgent to Wanniski and his opinion page. When stagflation emerged in glory, however, conditions were so unusual that curiosity about Laffer’s economics turned into dedicated interest. Arthur the Convener had made his debut as such the month before, in the form of a conference Laffer organized with economist David Meiselman, a collaborator of Friedman’s, at the American Enterprise Institute (AEI) in Washington, DC. The topic of the conference was The Phenomenon of Worldwide Inflation, the title of the proceedings which came out the next year. This was where Wanniski first met Mundell. The conference was ecumenical. It strove to have as speakers representatives of the wide range of ideas in economics about why the Great Inflation, as it was beginning to be called, was settling in. “Monetarists, fiscalists, cost-­ pushers, structuralists, and incomes policy advocates,” all were welcome, as Laffer and Meisleman wrote in the proceedings’ 1975 introduction. They thought “it would be useful, indeed essential, to bring together leading scholars representative of the major schools of thought on inflation” while emphasizing its international aspect. Laffer and Mundell gave talks characteristic of the views they had put forth in the journals. Laffer again touted Moon Hoe Lee’s research on the consistency of degrees of



devaluation and domestic price-level increases. Mundell gave a rollicking address mocking oil as “the crisis in fashion” in 1974 but noting that all commodities were soaring in price. He also stressed that “the tax effects of inflation on stock prices”—the American capital gains tax, which Nixon had raised to 35 percent, was not indexed for inflation—“are only beginning to receive adequate consideration in policy discussions.” In summarizing remarks Mundell made beyond the paper he submitted, the proceedings editors noted that he “supported a policy mix focusing on tax reductions and control of worldwide monetary aggregates.” This was the developing policy mix of nascent supply-side economics: tax-rate cuts (what Mundell was effectively endorsing via indexing) and monetary reform along the lines of re-approximating Bretton Woods. Meltzer spoke in the vein of the SOMC, advocating money-supply-­ slowing gradualism. He marveled at the diversity of views among economists explaining the inflation. Such diversity implied that the profession was at wit’s end about this urgent problem. Fortunately, he said, not everybody was on the program. “I am grateful to have been spared the oil-energy view, the beef-shortage view and other examples”—toilet paper?—“that I lump together as the worm’s eye view, or perhaps views, of inflation.” Other presenters included Herbert Stein and Walter Salant. Gottfried Haberler of Harvard University and AEI, who had written to the Journal critically of Laffer’s “Bitter Fruits” piece several months before, gave the plenary address. In somewhat vague fashion, it called on the United States to “put its internal financial house in order” so as to “take the lead in the fight against inflation.”10

Two Continents When Wanniski met Mundell and wrote up that economist’s perspective on inflation, with Laffer’s, in May and June 1974, he was intrigued to hear that in the fall, Mundell would be taking up a professorship at Columbia University in New York, where he and Bartley lived care of their work at the Journal. Mundell was leaving Waterloo for Columbia, where he would stay for the remainder of his career. Laffer was back in Chicago but traveled often. Wanniski planned on seeing the two of them as much as possible, and to bring Bartley along now that stagflation was becoming a problem of epic proportions. Over the next several months, Laffer worked on an economic model derived from his notion of the endogeneity of the money supply, as well as



the effects of the various kinds of government spending on output in his and Ranson’s OMB model. As he scratched out the equations, derived graphs, and wrote short prose explanations on dozens of pages of notepad paper, he produced a graph that would become one of the most famous of modern economic history. This was the tax-rate versus tax-revenue graph that beginning several years later would come to be known far and wide as the “Laffer curve.” It is important to note that the Laffer curve per se first came to public attention in 1978, care of the remarkable story Wanniski told about it in his book of that year, The Way the World Works. In 1975, in a footnote in an article for a policy journal, Wanniski briefly referred to a theory Laffer had showing that tax rate increases could bring declines in revenues. In the book of 1978, Wanniski took everything up a big notch. He recounted that one evening late in 1974, he and Laffer were having dinner at a Washington restaurant, the Two Continents, in the complex of the Willard Hotel across the street from the treasury building, with Richard Cheney, President Ford’s deputy chief of staff (and Laffer’s former Yale classmate). As Laffer strove to make a point, he took out a pen and on the “back of a paper napkin” drew his curve “for the first time.” As economist Robert Shiller has shown, once Wanniski published this story, mentions of the “Laffer curve” in the print media went “viral.” Newspapers and periodicals mentioned the Laffer curve about as much as they would, several years later, the demonstrably viral pop-culture toy phenomenon the Rubik’s cube.11 These rather stunning developments belong to another era, of 1978 and beyond, inclusive of Ronald Reagan’s winning the presidency and setting up tax legislation in the spirit of the Laffer curve. As goes 1974 and the origins of the curve in Laffer’s work, this is a matter that requires analysis of evidence. Wanniski is the one who identified, named, publicized, and proposed the origins of the Laffer curve. It is important to note that Wanniski did all this after the fact, namely in the Way the World Works of 1978 and its pre-publication excerpts of early that year. In the methods of history, these are called non-contemporaneous sources composed by either a direct or an indirect witness. The napkin-drawing of the Laffer curve took place in 1974, in Wanniski’s account, meaning that a source that testifies to that fact in 1978 is non-contemporaneous. If the restaurant meeting was the “first time” Laffer drew the curve, then Wanniski was a direct witness to its creation. If it was not the first time, then Wanniski was an indirect witness to its creation, seeing it at the restaurant after it had



been created. Laffer was the sole direct witness to its creation if he had drawn the curve in private prior to the napkin meeting. The evidence we now have indicates that marvelous as Wanniski’s story is, as crucial as it was to making the story go viral and enter American political-economic discourse and influence policy, it is probably incorrect on one count. At the restaurant was not the first time Laffer drew the curve. In Laffer’s archives is a series of notepaper pages—the pages Laffer was using to develop his new model in 1974—which includes the Laffer curve drawn in Laffer’s own hand and derived from equations accompanying it. This series of notes is a contemporaneous source regarding the drawing of the Laffer curve in 1974, and one composed by a direct witness to the event in question, the drawing of the curve. That direct witness was Laffer himself. In the canons of historical method, this is an evidentiary advance. Where before we had non-contemporaneous indirect sources, now we have a contemporaneous direct source—in regard to the origins of the Laffer curve. These notes may well represent the first time Laffer drew his curve. They almost certainly predate the restaurant meeting at the Two Continents. Their exact dates are not entirely clear. Various contextual clues indicate they could have been composed at some point as early as late 1973, probably during 1974, and possibility in early 1975 (the latter supporting the “first time” drawing at the Two Continents). The important point is that the Laffer curve clearly emerged from economic model-­ building, on Laffer’s part, at this juncture in his career. One part of Wanniski’s remarkable story that should prompt questions in the mind of a practitioner of economics is: how does one spontaneously draw a graph without doing the equations first? Almost universally in economics—Mundell being a textbook case—economists work out their mathematics, and after that work is done draw up the solutions in graphs. Graphs imply solutions already achieved. Graph first, equations second would mean no prefatory mathematical work, no combining of equations, no canceling of terms, no solving for dependent variables before the graph. This is difficult to see in that typically solutions are hard to come by and require thought and work. Before a mass of equations is solved, it can be an unruly mess of unworked-out expressions. Graphs coming first cuts out all the forbidding work of getting to the simple finish. The evidence now extant shows that there was extensive mathematics and canceling of terms and so on, in the service of this probably earliest Laffer curve. Moreover, the very existence of extensive work in equations



yielding this Laffer curve is itself tantamount to warranting the claim that the Two Continents restaurant napkin drawing was not “the first time” for the Laffer curve. If it was, and these notes date from 1975, then Laffer somehow intuited, at the restaurant, a curve whose implied equations worked out perfectly when he went home to summon them from the graph. This would require his being something of an unknown graphological genius. To date, however, Laffer’s graphs were rare and pedestrian. The tax-rate, tax-revenue “Laffer curve” appears several places in this series of notes. Most prominently, it is on the bottom of a page on which the curve is derived from an equation and graph at the top of the same page. (See a photograph of this page in Fig. 8.1.) The derivation of the bottom curve from the top graph amounts to proof that Laffer did not draw his curve spontaneously in specifically this case, but rather that he reasoned it out algebraically from prior premises. The derivation appears to have proceeded, mathematically, as follows.12 This top graph is of a “single-factor, competitive” model. The x-axis is the amount of the factor produced, the y-axis wage rates involved in the production of that factor. There are two curves against this x-y axis, a flat demand-for-factor curve and a supply-of-factor curve that is upward sloping by degree a1. The dynamic displayed in the graph is a movement down the supply curve when there is a fall along the y-axis, in the case in which wages received, Wr, diverge from wages paid, Wp, on account of a tax rate, Tr. The decrease in wages received, when wages paid stay the same, care of Tr, results in a decrease in the amount of the factor produced. The degree of this decline is the slope of the supply curve multiplied by the tax rate, or a1 multiplied by Tr. The equilibrium condition is noted as follows: Fe = a0 + a1Wp − a1Tr. In descriptive language, the amount of production (Fe) is equal to that produced under nearly all conditions (a0), plus the slope of the supply curve times the sum of wages paid (a1Wp), minus the slope of the supply curve times the wage tax rate (a1Tr). After this graph and its several attendant equations are spelled out at the top of the page, a new set of equations is introduced. These are directed toward TTr, or total tax revenue, a concept not explicit in the first graph or equations but implied in them, as the remainder of the page shows. The independent variables of the first graph—the tax rate Tr, the slope of the supply curve a1, and wages paid Wp written in proxy form α—along with the dependent variable which a combination of these independent variables equals, the total factor production F—are themselves



Fig. 8.1  The Laffer curve as derived in Laffer’s notes, ca. 1974

sufficient to indicate total tax revenue. Total tax revenue is the tax rate multiplied by the production of factors, given that there is only one input to production in the model, namely wages, and it is what is taxed. TTr therefore equals Tr × F. As the equations continue down the page, F equals a0 + a1α − a1Tr, so this expression multiplied by Tr equals total tax revenue. (Rearranging the identity would show that factor production equals total tax revenue divided by the tax rate.) He then differentiated this equation with respect to the tax rate. This is the equation that yielded the Laffer curve. It is dTTr/ dTr = a0 + a1α − 2a1Tr, which is the first derivative of Tr(a0 + a1α − a1Tr).



It expresses the change in tax revenue as a function of the change in the tax rate. Laffer then worked out the calculus scenarios where decreases and increases in dTr would lead to decreases and increases in dTTr. He called the negative values of the change in total tax revenue against the change in the tax rate (i.e., where dTTr/dTr is less than zero) the prohibitive range, and positive values the normal range, calling on common tax rate/ revenue language dating back to the tariff debates of the nineteenth century. Below these calculations he drew the curve expressed by the differential equation, the Laffer curve as it came to be known, perhaps for the very first time. This curve switched the conventional spatial relationship implied by a differential equation. Typically, a differential equation is expressed as the change in y (the dependent variable) over the change in x (the independent variable), as indeed is Laffer’s dTTr/dTr equation. When such an equation is graphed, the dependent variable y is plotted on the ordinate vertical axis and the independent variable x on the abscissa horizontal axis. In graphing his equation, however, Laffer reversed the variables, making tax rate values the y-axis and total tax revenue values the x-axis. Perhaps he was representing the tax rate as the price on the y-axis and total tax revenues as the quantity on the x-axis, as in price-quantity curves since the time of Alfred Marshall. In this context, it is essential to note that the Laffer curve, in this defining probably initial derivation, was not a normal curve, not a distribution of observed outcomes of the Gaussian or any variety. Rather, an equation determined this curve. In a statistical distribution, it is typical to present a curve in a “bell” shape, which in this case would have reversed the two axes. This curve was, however, not such a curve, not one capturing or estimating a distribution. Its arrangement protruding outward in bulbous fashion is a marker of its category. This probably urtext Laffer curve was not an attempt to represent observed outcomes. Rather, it shows the path determined by a solved equation. The Laffer curve in this drawing has no specific magnitudes. In the equation, the variable a0 represents the level of production that nearly always occurs no matter the tax rate. Thus the top tax rate in the graph is some level over 100 percent. The point at which the plot intersects the y-axis at the top, given a0, implies that wage-earners’ income, at that point, is negative. In addition, the tax rate in the Laffer curve in these notes is an



aggregate tax rate for the whole economy. It is total tax revenues divided by output. Laffer’s use of the notation TTr, total tax revenue(s), meant that the x-axis values could, on the extension of the model, incorporate all tax revenue in an economy, not merely that absorbed by the taxing entity responsible for any Tr. Total tax revenues conceivably could refer to the sum of tax revenues from all taxing entities operating in the context of the model, whose bounds could be no less than the world economy. This first (or early) Laffer curve permits the assumption that a given taxing entity, that responsible for Tr, affects not only its own revenue by setting a rate of tax, but the revenue of all other taxing entities relevant in the economy as well. Given that any Tr involves disincentives, as expressed by the positive slope of the supply curve which is followed downward when wages paid diverge from wages received, the drop in production resulting from one tax rate involves a decline in the tax base for all taxing authorities.13 Next to the curve are three lettered points about the economic effects of tax-rate changes. The first, “a.),” is the loss in total output necessitated by any tax rate, which in Laffer’s equations corresponded to the negative of the slope of the supply curve, or −a. The second, “b.),” is the loss to taxpayers from any tax rate Tr. And the third, “c.),” is the gain to government-­revenue recipients (the recipients of government spending) via TTr from any given Tr. Beneath the lettered points and the curve itself is a brief function expressing that the utility gained by recipients of government spending should be greater than that lost by taxpayers plus that lost by the movement down the supply curve because of taxation. This extensive page of graphs and equations was perhaps the first time Laffer worked out his curve in full. This page is part of a twenty-six-page series of similar notes and graphs developing a two-factor economic model. The two factors are capital, K, and labor, L. Explicitly in these other pages Laffer was striving to determine, explicitly, the “wedge”—he had used the term discussing social security with Ranson in 1973—between income charged for economic production and income received from the charging for that same production. That difference, the wedge, is the residual after a tax rate Tr is imposed. For example, in these pages beyond the main one with the Laffer curve on it, he had a supply-of-capital and a demand-for-capital plot. It cleared at r, the rental-rate on capital. At the “Introduction of Wedge,” as in the heading above a graph, there is a tax imposed affecting r such that it becomes a higher rate rp, meaning the rental-rate paid, as well as a lower



rate rr, or rental-rate received. The supply and demand curves no longer intersect, forcing changes. Laffer worked them out in differential equations. He did the same for the demand of and supply for labor, as affected by the imposition of a wage tax (such as social security) that creates a difference between wages paid and received. After several pages of further graphs and equations on the theme of capital and labor supply-and-­ demand, with taxes imposed in each case, he described the effects in prose: In the case of a transfer fixed per unit of capital employed we find the following in general must hold: (a) The rental rate paid to a unit of capital must rise. (b) The rental rate received by a unit of capital must fall. Thus the rise in the rental rate paid is not as great as the newly imposed transfer. (c) The wage rate paid to a unit of labor as well as the wage rate received by a unit of labor must fall. (d) The total supply of labor will fall. (e) The total supply of capital will fall by even more in proportionate terms than the supply of labor.

He continued with reflections on elasticities and noted that in nearly all but the extreme cases of no elasticities, “output, of course, falls.” In these notes, Laffer was drawing on central aspects of the economics of his Chicago colleagues. Most notably, he was applying the various theorems Mundell had introduced in his 1960 AER article on “The Pure Theory of International Trade” and excerpted in Mundell’s widely read 1968 textbook International Economics. In the sections of these works on the “transfer problem,” or the case when one country transfers income to another (such as in the case of reparations), Mundell strove to identify with precision the various “dynamical” implications. Broadly, Mundell found that a transfer to a country results in an income-increase in that country less than the amount of the transfer. This was so in the first place because the income of the transferring country is lowered, reducing the purchases of the receiving country’s exports. He demonstrated, second, that taxes imposed to fund the transfer payment change the terms of trade, and thus the production possibilities, of the paying country, with commensurate effects on the receiving country. And third, he stressed the implications for capital movements when such impositions are made.14 Laffer’s notes applied analysis of this type within a domestic economy, with the “transfer” not going abroad but staying within that economy. The effects, excluding capital movements which are not treated in these



notes, were similar. The imposition of a tax caused less output, and therefore less goods and services for the recipient of the transfer to buy. This was analogous to Mundell’s reparations’ receiver not getting the full real amount of the transfer. In the main page with the Laffer curve, at the bottom is the utility function indicating that the utility gains care of the transfers would have to be greater than the losses they occasion. Furthermore, in place of the terms of trade, Laffer’s model proposed that the offer of capital and labor supply in an economy shifts, given taxation on these factors, in the direction of less commitment of productive resources. Another Chicago colleague of Laffer’s had traces all over these notes. This was Arnold Harberger. His “welfare cost,” typically referred to as a “deadweight loss”—a term Harberger adopted from Samuelson and popularized—accrues when deliberate deviations are made from perfect market competition. Graphically, deadweight losses take the shape of triangles, three-sided blocks to the left of the normal equilibrium point of the supply-­demand curve. A typical “Harberger triangle,” the term being in wide currency in economics by the 1960s, is defined by the original supply-­ demand equilibrium point and two new points. The first new point is on the demand curve upward to the left, the second on the supply curve downward to the left. These new points are established by the intersection of a vertical line representing market-clearing levels after the introduction of some distortion to normal equilibrium, such as an impediment to production (a poor monopoly producer for example) or a barrier to purchasing (such as sales taxes). The triangle made by the three points, the original equilibrium point with the new demand point above the new supply point, is the “Harberger triangle.” Its area represents the volume of lost output resulting from the change, or the deadweight loss. The Laffer note series of 1974 is filled with Harberger triangles. A prominent one is on the main page with the rate-revenue curve. It is the shape made above and to the left of the supply function on account of the disjunction between wages paid and received from the tax rate. When he refers to them in the note series, Laffer calls them not triangles but “wedges”—he would encourage the use of this term in the upcoming years. Indeed, before Wanniski popularized the Laffer curve in 1978, Laffer may not have thought much of it, in that the wedge was the issue that he emphasized in his public policy-work in the mid-1970s, especially in the Congressional testimony which he was increasingly offering beginning in 1975.15



Michael 1 The notes yielding this very early, possibly first Laffer curve were an initial outline of the “Prototype Wedge Model” which Laffer submitted as completed contract work to H.C. Wainwright in 1978. The argument that the Laffer curve was disconnected from model-building must now be retired as invalid by the canons of evidence. That he wrote it on a napkin at some point in the latter part of 1974 is probably correct. The sources for this episode are all non-contemporaneous, but they point to this conclusion all the same. Wanniski first recounted the episode in published form in 1978 and over the years afterwards added further details, including that another person, Republican staffer Grace-Marie Arnett, was present. Some accounts have it that Cheney’s administration superior, Donald H. Rumsfeld, was there too. The Smithsonian Institution has a cloth napkin that it perhaps initially supposed was the actual napkin from late 1974 but rather clearly is a later commemoration of the event. The Smithsonian napkin was probably made in 1977, as Wanniski was writing his book and about to spring the curve on the public. The reason is that prior to Wanniski’s plan to publicize the curve, it had no notoriety at all.16 It is important to note, with Robert Shiller, that the napkin story was essential to the Laffer curve’s pull with the public, to its “going viral.” If Wanniski had said nothing about the back of a napkin, but instead wrote that here is an economist from the University of Chicago who has worked out a model, and this is his curve from that model, he would have lost a popular audience. Moreover, economics was in a shambles before the public in the mid-1970s as it floundered before stagflation. The misery index was hitting 20 and there was a big reigning prestigious economics establishment—two things together that were intolerable. To present Laffer as a renegade, publishing not in the journals—which had failed the country as stagflation testified—but in the heat of policy discussion on a napkin corresponded to the perfectly appropriate desire on the part of the nation for someone to buck the normal processes of economics and say something stunningly clear and unconventional. As for having dinner and intensely talking economics as stagflation roared, this became a major pastime of the nascent supply-side four: Laffer, Wanniski, Bartley, and Mundell. The meeting with Cheney was one of a great many. Beginning at some point in 1974, as Bartley remembered it, these four began meeting at a Wall Street restaurant called Michael 1. Various guests came and went, and Charles Parker of Wainwright attended



and picked up the tab. The purpose of the dinners was for the journalists and other guests to comprehend and come to terms with Laffer and Mundell’s diagnosis of stagflation and plan for escaping it. As Bartley put it, the Michael 1 meetings were “extraordinary seminars in economics.” The one person who needed some conversion was Bartley himself. This heir to eloquent fiscal conservative Vermont Royster at the helm of the Journal editorial page, Bartley was concerned about putting any fiscal priority, even tax-rate cuts, before the cutting of government spending. Among all the published works on the history of supply-side economics, the memoirs prepared by certain of the main participants remain the most lucid and penetrating, typically exceeding in analytical power and quality the scholarship on the topic of the forthcoming years. Congressional, Treasury, and Journal staff member Paul Craig Roberts’ memoir The Supply-Side Revolution (1984) is an unparalleled account of the movement in the halls of Congress and the strategy and tactics needed to get legislation passed. Reaganomics: Supply-Side Economics in Action (1981) by Bruce Bartlett, the assistant Rep. Jack Kemp assigned to compose his tax cut, is a remarkably taut and complete narrative of the movement in the decade to Reagan’s arrival at the presidency. Roland Evans and Robert Novak’s Reagan Revolution (1981) replicated the reliable reportage of this pair’s newspaper columns in book length, inclusive of extensive treatment of the supply-side movement. But among all these, the one memoir, “dare I say it—it’s fun” to Peggy Noonan, that can be taken as a history-­ of-­political-economy textbook of the 1970s and 1980s is Bartley’s from 1992, The Seven Fat Years.17 The third chapter of this book is an extensive description of what happened at Michael 1. Its central characters were the four, the author and Wanniski, Mundell, and Laffer, “one of the fastest-talking and most entertaining people alive,” as Bartley wrote. But “the Michael 1 seminars did not arise from accidents of personality. They were a product of their time; their roots lay in the economic and intellectual turmoil of the 1970s. For as stagflation of the 1970s had upset the political universe, so it had overturned intellectual orthodoxy. We needed a new economics, and the assumptions and insights flowing from those discussions constitute an economic world view.” Bartley, with Wanniski, the editorial-page leadership of the Wall Street Journal, was interested as of 1974 in learning the economics that these two academic opponents of the post-1971 status quo had been developing since, in Mundell’s case, the 1950s. It was the genesis of a remarkable partnership between representatives of the worlds



of scholarly economics and practical affairs. Over the upcoming years, the relentless editorials of the Wall Street Journal in the Mundell-Laffer vein cascaded, care of the newspaper’s vast and influential readership, comprehensively into the precincts of the business and policy elite of the United States. In 1980, when a participant at the Republican National Convention mentioned to Novak that Bartley was his hero, it surely had in some good part to do with the economics Bartley forwarded on his page.18 In 1975, as Bartley recounted in this chapter, he was giving a talk in Washington on “crowding out”—how deficits starve the private markets of capital. He was interrupted by Rep. Jack Kemp, whom he had never met and who asked him if he would raise taxes for the purpose. Bartley thought the question “penetrating.” At Michael 1, Bartley remembered, “Art Laffer…was nearly apoplectic over my crowding-out editorials.” He confided, furthermore, that “while I thought ‘crowding out’ a big leap in my own thinking, Laffer kept asking, ‘Don’t you see that it happens on the real side.’…What counts is government control over real economic resources….It’s not government borrowing that crowds out the private sector, but government spending.”19 Bartley started to consider the Laffer curve—Wanniski must have encouraged Laffer to discuss it at Michael 1—and in his memoir had this reflection: Basic economics textbooks talked about a mythical creature called “the balanced budget multiplier,” with magical powers to transmute a bigger government into a healthier economy. If the government spent an extra $20 billion and raised taxes $20 billion, all of the spending would be consumed, and some of the taxing would come out of savings rather than consumption. So on net, consumption would increase, and be multiplied into a bigger GNP. This was solemnly taught to innocent sophomores by professors who later ridiculed the Laffer curve.

Bartley found Keynesianism stale, unlikely, and a professional talisman, and Laffer one of the few with an approach to economics that corresponded to the current conditions. In part, Bartley was being experimental. As Monica Prasad cited Laffer and Bartley on this issue in her sociological history of the Reagan tax-cut movement, “as Arthur Laffer himself put it, in a phrase that actually sums up the whole episode: ‘There’s more than a reasonable probability that I’m wrong…why not try something new?’ Robert Bartley…at the eve of the policy victory [in 1981]



said, ‘I think these are very important ideas. But I couldn’t give you any guarantee that they’ll work. Maybe they won’t. I just can’t see anything else on the horizon.’”20 In a technical sense, Bartley was correct in observing, “I just can’t see anything else on the horizon.” This was the official, published judgment of the leading new representatives of the macroeconomics profession. In 1979, the future Nobel Prizewinners Robert E. Lucas and Thomas Sargent wrote a stunning summation of the state of the field. This was several years after the 1973–75 recession had finally broken, but during a recovery in which inflation maintained itself at 7 percent, en route to yearly double-­ digits in three consecutive years from 1979–81. As Lucas and Sargent put it to begin their piece in a Federal Reserve journal: For the applied economist, the confident and apparently successful application of Keynesian principles to economic policy which occurred in the United States in the 1960s was an event of incomparable significance and satisfaction. These principles led to a set of simple, quantitative relationships between fiscal policy and economic activity generally, the basic logic of which could be (and was) explained to the general public and which could be applied to yield improvements in economic performance benefitting everyone. It seemed an economics as free of ideological difficulties as, say, applied chemistry or physics, promising a straightforward expansion in economic possibilities….Noneconomists met this promise with skepticism at first; the smoothly growing prosperity of the Kennedy-Johnson years did much to diminish these doubts. We dwell on these halcyon days of Keynesian economics because without conscious effort they are difficult to recall today. In the present decade, the U.S. economy has undergone its first major depression since the 1930s, to the accompaniment of inflation rates in excess of 10 percent per annum…. These events did not arise from a reactionary reversion to outmoded, “classical” principles of tight money and balanced budgets. On the contrary, they were accompanied by massive government budget deficits and high rates of monetary expansion, policies which, although bearing an admitted risk of inflation, promised according to modern Keynesian doctrine rapid real growth and low rates of unemployment. That these predictions were wildly incorrect and that the doctrine on which they were based is fundamentally flawed are now simple matters of fact involving no novelties in economic theory. The task now facing contemporary students of the business cycle is to sort through the wreckage, determining which features of that remarkable intellectual event called the Keynesian Revolution can be salvaged and put to good use and which others



must be discarded. Though it is far from clear what the outcome of this process will be, it is already evident that it will necessarily involve the reopening of basic issues in monetary economics which have been viewed since the thirties as “closed” and the reevaluation of every aspect of the institutional framework within which monetary and fiscal policy is formulated in the advanced countries.

Bartley’s Seven Fat Years made the point repeatedly that Michael 1 was a response to the emergence of an intellectual vacuum at a highly inopportune time. This was the strange situation in which there was a phenomenally prestigious and self-satisfied economics establishment at its acme while an extended economic time of troubles came over the nation. This stagflation was at once painful and dispiriting as well as officially inexplicable. As James Tobin said speaking in the Lucas-Sargent vein in 1980, “I will just give my own observations and confess my own puzzlements.”21 In Bartley’s analysis from the early 1990s—the years of the George H.W. Bush presidency during which Bartley was concerned about the possibility of a renewal of long-term stagnation—Michael 1 represented an attempt at intellectual rejuvenation in the context of not only economic torpor, but a society calling for paradigm shift. As Bartley wrote of the policies that would emerge out of the supply-side revolution, beyond the “specific steps,….there was also a broad social movement fully evident as early as 1978, not only a ‘tax revolt’”—against California property taxes, in which Laffer played a central role in designing the referendum—“but a change in American feelings and understandings, a reassertion of American optimism and creativity.”22 What Laffer and Mundell found themselves in, with Bartley and Wanniski and the others at Michael 1, was a leading edge of what political science via Max Weber calls a “legitimation crisis.” A major sociological hegemon, the profession of economics, had produced, or at the minimum been complicit in, the cashiering of remnant classical economic arrangements in favor of techniques of governmental economic management whose result was stagflation. This was an epic failure. To the public, the immediate matter was not that heads roll. That there were tenured professors at tony institutions intoning on economics was alternatively infuriating and laughable. The immediate matter, rather, was that the situation be wrestled with in a new more prospectively productive way. The American people had to have their prosperity. Dealing with the problem that was the economists was secondary. When Laffer and Mundell presented



themselves, at Wanniski’s goading, Bartley functioned as the connection between the world of renegade scholarly ideas and the aspirations of the public. Economics emerged from the stagflation interregnum not only fully intact, however, but with renewed confidence and with an attitude. Stigler, for example, in 1984 published an article called “Economics: The Imperial Science?” a question which he very much answered in the affirmative. He recounted how the modes of analysis pioneered in the economics journals were comprehensively influencing, were colonizing, the range of social scientific disciplines. Political science, law, anthropology, history, all of them had been deeply infected by the modes of economics—“utility-­ maximizing behavior,” for example—in large part begrudgingly at the hands of “economist-missionaries.” Other disciplines, Stigler implied, had to accept the methods and lessons of modern economics or get swept into economics itself. It was the Standard Oil model of inquiry. Sell to Rockefeller now or beg to be sold to him later.23 Standard Oil was, however, one of the greatest businesses ever run on any normal metric involving benefit to the consumer. Nothing of the sort could be said of economics even two years before Stigler published his article. It was a remarkable act of hubris, of assuming the pose of the victor in the general environment of a flush of success. By 1984, the economy had turned decisively. Growth was powering at collectively 12 percent in real terms over 1983–84 as inflation went back to pre-1969 levels. The stock market kept reaching for all-time highs, having lost 75 percent of real value over the extended stagflation interregnum, 1966–82. Had an article with Stigler’s tone come out in 1979, when Lucas and Sargent’s did, it would have represented the peak of cluelessness. It is hard to see such an article’s being accepted, even if by a recent Nobelist (Stigler won the prize in 1982), unless to exhibit how such people when indulged can be cranks. The thousand fathers who laid claim to the defeat of stagflation, via the noninflationary boom across the 1980s and 1990s, include the economics profession itself. It developed “rational choice” models that corrected Keynesian misapprehensions. Keynesianism, for its part, re-grounded itself in a tighter mode of “fiscal discipline” that found its distinct policy realization in the economics of President Bill Clinton. The predominant left-­ wing portion within the profession holds that stagflation was not dispatched circa 1981 but traded out for a more malevolent structural problem, income inequality. Yet when practicing the usually recommended



spare methods of history, interpreting those individuals with proximity to events as top candidates for causation, it is difficult to say that Bartley’s Michael 1 group was not the vanguard that made up, to some considerable extent, the efficient cause of stagflation’s eventual reversal. Whether economics was at fault in the 1971 debacle and whether the Laffer group mattered in the policy revolution that began to be implemented with the tax revolts of 1978 are complex questions concerning the historical process. The premises of the terms remain in dispute. Economics in general continues to regard fixed rates, at least beyond the manifest successes of currency boards in second-rank nations, as some sort of barbarous relic the world is happy to be rid of. This is not to mention the mystical scorn the university economics guild heaps on convertibility in gold. Yet the strong empirical association remains that as of 1971, economists had goaded on policymakers for years into dropping gold and then fixed rates. The few countervailing voices within the top echelon of economics, including Mundell, Laffer, and his adviser Despres and his colleagues, had their allotment of time and space to give their views, and they lost out. Economics has never apologized for 1971; the profession still regards the moves away from gold and fixed rates as the right ones and affixes causation of the 1970s on other factors. Yet economics either alternatively takes credit for the major 1980s–1990s expansion—with the collapse of inflation attributed to hard-headedness at the Federal Reserve—or denies those accomplishments by insisting that they were paid for with the vile currency of a dramatically grown underclass. The methodologically parsimonious conclusion was that offered by Bartley. Economics had failed by 1974, the public demanded better, and in that context a process emerged whereby those select economists who could see the way out were shoved to the fore, if in an unconventional manner via the likes of intensive discussions and tutorials over steaks and martinis at Michael 1. In this interpretation, Laffer was ready for his role. But it was the aspirational structure of a complex society accustomed to affluence that assigned it to him.

Capital Moves As for what Bartley took in from Mundell, in particular, at Michael 1, he summed it up in a phrase. Bartley asked Mundell how tax-rate cuts might be paid for if it turns out that the tax system had not been on the prohibitive side of the Laffer curve. “The Saudis will finance that” was Mundell’s



reply. It was a very Mundellian reply. Ever since his “dynamical” articles of fifteen years before, Mundell had been emphasizing the proportionately enormous effect that international capital movements have on economic systems. They made Keynesian domestic-economic management look like a sandbox. If there is opportunity in the United States, the world’s capital will flow to it. This is far larger than any “savings pool” or the like in any one nation, including the United States.24 In Laffer’s economics, the multiplicity of world central banks was the guarantee that no good financing vehicle in any nation would fail to attract investment. The key, however, was fixed exchange rates. If the American bank was too tight, fixed rates would permit any amount of foreign currency to come into the country converted into dollars at par. Flexible rates exploded Laffer’s system. As he wrote it up in the Journal in 1974 (in an article on which Bartley commented in extended fashion in The Seven Fat Years), per Moon Hoe Lee’s research, every percentage point of the devaluation shows up in the increase in the price level. Flexible rates remove the possibility of bringing in another’s currency when one’s own is under-­ produced—or the reverse, of taking one’s own currency abroad when it is over-produced. The exchange-rate change, in each case, eliminates the integrity of the thing that one is trying to move across borders. It was like a perishable good. Under fixed rates, bringing a currency to another country to trade is to arrive with the same thing as one brought. Under flexible rates, it is to arrive with a different, and usually more undesirable thing. For starters, it wards off purchasers in the foreign marketplace, in that this import may depreciate. Mundell, far more than Laffer, had already worked out a full range of economic implications of flexible exchange rates. In his classic articles from the 1950s and 1960s, he included the flexible-rate case alongside that of fixed rates. Interpreters have seen the influence of Mundell’s Canada, which had toyed pace Bretton Woods with a floating dollar since the 1940s. No doubt this experience mattered to Mundell. But his articles were by nature so comprehensive, the idea that he would leave out this major alternative was unthinkable, no matter his nationality. Mundell was prepared for the 1970s in his monetary economics. As he wrote in 1968, he knew that floating rates would create inordinate demand for the major invoice currency, the dollar, as well as similar demand within the still-­ backwater market of currency-trading. Laffer’s exploration of fiscal policy, beginning with his OMB work and lasting through his early outlines of the Laffer curve, represented the need



his economics had, with the rise of flexible rates, for some kind of spontaneous driver of economic productivity. He had something akin to this in his fixed-rate economics. The monetary flows from abroad, guaranteed at par under fixed rates, ensured that any economy that harbored real productivities did not impose a monetary barrier to those productivities. They would be financed. With this system gone by early 1973, it forced Laffer, unlike Mundell—who had a stronger sense of the nature of comprehensive capital flows across the global economy under flexible rates—to think more directly about domestic productivity. If he could isolate aspects of the dynamics of domestic productivity, he could identify how monetary policy under flexible rates was failing it. Initially, Laffer’s economics included an implicit theory of stagflation that accounted for the sagging of growth from the efficiency losses of the effort to restore the relative price structure (the inflation) after a devaluation. But the recession of 1973–75 was too severe for such an explanation. Monetary demand as well as economic supply were collapsing. A factor at the point of the engagement in production was in play, and Laffer moved to identify it. He found it in his wedge. Mundell may have been initially more complacent on this question, owing to his confidence in capital moves to the United States given the primacy of the dollar. About one point they were in complete agreement. This was the oil crisis. Bartley reproduced documents reflective of the group’s views in The Seven Fat Years. He cited verbatim a resolution from the Organization of Petroleum Exporting Countries (OPEC) from September 1971: Concerning the recent international monetary developments and their adverse effect on the purchasing power of the oil revenues of Member Countries [and] noting that these developments have resulted in a de facto devaluation of the United States dollar, the currency in which posted prices are established, [a former resolution] calls, inter alia, for adjustment in posted tax-reference prices so as to offset any adverse effect  resulting from…changes in the parity of monies….Member countries shall take necessary action…to offset any adverse effects on the per barrel real income of Member Countries resulting from the international monetary developments as of 15th August 1971.

Mundell and Laffer wholly interpreted the 1973–74 oil shock as a consequence of devaluation. Mundell went on about it at the AEI conference. Laffer’s initial plans for supply-side policy, as he presented them to



treasury secretary Simon late in 1974, included decontrol of the domestic oil industry so that local producers could take advantage of, and to some small degree limit, the price increases.25 The pair’s argument about the oil shock followed from several premises. The first was Mundell’s, that flexible rates would enhance the dollar’s role as an invoice currency. After the dropping of gold and the progressive dollar devaluations through early 1973, the oil producers could have dropped the dollar as an invoice currency in favor of some more value-­ retaining alternative. But this would have required choosing one. The only conceivable candidates were the West German mark, the Japanese yen, and the Swiss franc. Yet this would have required monetary expansions on the part of those currencies’ central banking authorities, the absence of which was a plank in those currencies’ favorability in the first place. Moreover at every point of sale in the oil markets almost to the retail level, global suppliers and service providers expected settlement in dollars and were not prepared to bank and hedge the likes of the Swiss franc. There was no choice. Oil had to continue to be invoiced in dollars. Laffer’s point came next. Given that devaluations require the restoration of the relative price structure, oil staying at its 1971 nominal price in 1973 made no sense. The whopping price increases in petroleum of late 1973 reflected an overshooting of oil’s place in the original relative price structure that in part compensated for oil’s being late to the inflation to begin with. This was on account of the suppliers’ decision-making not being diffuse given a monopolistic OPEC. In 1983, Laffer noted that as late as 1979, increases in the price of gasoline in the United States had, amazingly, lagged the rate of increase in the consumer price index.26 A further point is the one that intrigued Bartley. It brought together both the oil crisis and the Laffer curve. It brought Mundell into the Laffer curve. On the question of financing a marginal tax cut—and the marginal point would become clear via Laffer’s wedge arguments—Bartley conceded that outside of the prohibitive range, “of course…a tax cut would produce a deficit.” There would, however, be “reflow,” or tax revenues from increased economic activity, from growth, occasioned by the tax cut. These would be less than the full amount of the tax cut, but a portion of it all the same. There would be no crowding out by the rest beyond the reflow, however, because “the Saudis will finance that.”27 In Mundell’s economics, the rise of flexible rates and the canceling of the gold anchor led to profuse global monetary production. This created pools of money, including in reserve accounts, that would bolt to real



economic returns wherever they happened to arise. A marginal tax cut in the United States would occasion a profound effect in this direction. If the world’s most productive economy suddenly sported a greater take-home return on investment, owing to a marginal tax cut, the rush of global capital into that investment environment could be earth-shaking. One of Reagan’s early econometric advisers, John Rutledge, called the process “thermodynamic.” Among the choice investment vehicles would be dollar-­denominated US bonds. Therefore, after a marginal tax cut, there would be no crowding out.28 This is how Bartley came to move away from the “big leap in my own thinking”—crowding out—toward the Laffer curve. Financing of a budget deficit is not a matter, in a global economy, of the domestic savings allotment. If the United States is a supremely productive place with low inflation, fixed-interest instruments such as treasury securities will prove to be strongly desired the world over. Mundell and Laffer approached economics from the perspective of currency movements, and Mundell was the first to outline an economics of taxation in his early work on trade. The Laffer curve on its own was a theory of the utility implications of taxation within a given economy. When Bartley compelled himself to think about the curve, he sparked Mundell’s intelligence to verify that the payor of a stagflation-killing tax-rate cut would be the very origin of the problem to begin with. The monetary excesses of the 1970s would pay for the Reagan tax cuts of the 1980s.

Notes 1. Jude Wanniski, “The Case for Fixed Exchange Rates,” WSJ, June 14, 1974. 2. Mundell, “The Composition of International Reserves and the Future of the Dollar,” 48. 3. Bartley, The Seven Fat Years, 45. 4. Bartley, The Seven Fat Years, 186; Allan H. Meltzer, “The Shadow Open Market Committee: Origins and Operations,” Journal of Financial Services Research 18, nos. 2/3 (Dec. 2000), 120–22; William Poole, Robert H. Rasche, and David C. Wheelock, “The Great Inflation: Did the Shadow Know Better?” NBER Working Paper 16910 (March 2011), ii. 5. Paul A.  Samuelson and Robert M.  Solow, “Analytical Aspects of Anti-­ Inflation Policy,” AER 50, no. 2 (May 1960), 192. There is debate within economics about whether the critics of the Phillips curve improperly attributed the trade-off to Samuelson-Solow, as argued in James Forder, Macroeconomics and the Phillips Curve Myth (New York: Oxford University



Press, 2014). The extreme matter of Samuelson’s practice of strategic equivocation makes any effort at exonerating Samuelson from having said something an impossible task. See Phillip W. Magness, “Historical revision and the alleged ‘myth’ of an exploitable Phillips curve,” www.philmagness. com, Aug. 10, 2014. 6. U.S.  Department of Commerce, Business Conditions Digest, March 1974, p. 73. 7. Jacques Rueff, The Monetary Sin of the West, trans Roger Glémet (New York: Macmillan, 1972), 192. 8. Laffer, “Balance of Payments and Exchange Rate Systems,” 30; Mundell, “The Monetary Dynamics of International Adjustment Under Fixed and Flexible Exchange Rates,” 227. 9. Laffer, “Balance of Payments and Exchange Rate Systems,” 78. 10. David A.  Meiselman and Arthur B.  Laffer, eds.,  The Phenomenon of Worldwide Inflation (Washington, DC: American Enterprise Institute for Public Policy Research, 1975), 1, 7, 22, 24, 53, 148–49. 11. Wanniski, The Way the World Works, 288. 12. Untitled Laffer-curve note series, ca. 1974, Laffer archive. 13. Laffer’s emphasis on counting total tax revenues after a change in a single tax rate affecting directly a portion of the economy, in the 1970s and early 1980s, is canvassed in Bartlett, The New American Economy, 113–16. 14. Mundell, “The Monetary Dynamics of International Adjustment Under Fixed and Flexible Exchange Rates,” 228. 15. See Arnold C. Harberger, “Monopoly and Resource Allocation,” AER 44, no. 2 (May 1954), 77–87 and “The Measurement of Waste,” AER 54, no. 3 (May 1964), 58–76. 16. Binyamin Appelbaum, “This Is Not Arthur Laffer’s Famous Napkin,” NYT, Oct. 13, 2017. 17. Bartley, The Seven Fat Years, back cover. 18. Bartley, The Seven Fat Years, 43, 45; Robert D. Novak, “Who Is Robert Bartley?” WSJ, Jan. 14, 2003. 19. Bartley, The Seven Fat Years, 55. 20. Bartley, The Seven Fat Years, 46; Prasad, Starving the Beast, 107. 21. Robert E.  Lucas Jr.  and Thomas J.  Sargent, “After Keynesian Macroeconomics,” Federal Reserve Bank of Minneapolis Quarterly Review 3, no. 2 (Spring 1979), 1; Domitrovic, Econoclasts, 193. 22. Bartley, The Seven Fat Years, xxxii. 23. George J.  Stigler, “Economics: The Imperial Science?” Scandinavian Journal of Economics 86, no. 3 (Sept. 1984), 304, 312. 24. Bartley, The Seven Fat Years, 59. 25. Bartley, The Seven Fat Years, 31.



26. Charles W.  Kadlec and Arthur B.  Laffer, “The Oil Price Decline in Perspective” (1983), in Oil and Energy: Thirty-Five Years of Supply-Side Insights, ed. Brian Domitrovic (San Francisco: Pacific Research Institute, 2016), 18–19. 27. Bartley, The Seven Fat Years, 57–59. 28. John Rutledge, “Supply-Side Thermodynamics,” American Spectator, July/Aug. 2002, pp. 48–53.


Global Monetarism

When Wanniski had Laffer meet with Cheney in the fall of 1974, the meeting at which Laffer drew his curve on the back of a napkin at the restaurant, the recently inaugurated President Ford’s administration was struggling to deal with a whopping inflation problem. The problem was so acute that it overshadowed the recession that lasted every month of that year and then some, let alone the attendant rising unemployment. The possible dates for the Two Continents meeting range from September to December of that year, with the plurality of the evidence indicating early December. As of early December, four months into the Ford administration, prices were increasing at a remorseless 12 percent yearly rate. Economic output had fallen in three of past five quarters; unemployment had run up to 7.2 percent, en route to 9 percent in six months’ time; and while Laffer sketched on the back of the napkin, the major stock indexes were down over 40 percent from their brief 1972–73 high in the aftermath of Nixon’s re-election. If the Two Continents meeting took place on December 6, 1974, which it may have, that day was the secular trough, the floor, of the stagflation market. The Dow Jones industrials closed at 577. A level that low had not been seen since a dozen years before, during the Cuban missile crisis. Nor would it be seen again. If the meeting was that week or that day, perhaps Wanniski, Cheney, Laffer, or Grace-Marie Arnett got the word out and enough market participants reflected on the news that the © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 B. Domitrovic, The Emergence of Arthur Laffer, Archival Insights into the Evolution of Economics,




long-term trough took form. For the Laffer curve on that napkin was the presentiment of the forthcoming Reagan Revolution. Stocks would put on one of their greatest runs of all time, lasting eighteen years and involving a fifteen-fold increase in the major indexes, as the Reagan tax cuts came on beginning in 1982. Markets being characteristically far-seeing and practical, if participants got that first signal of the Reagan Revolution from the Laffer-curve napkin in December 1974, the trough forming precisely at that time might not have been coincidental. If there was a link, the Laffer curve had influence before Wanniski published it three-and-a-­ half years later. Given that the market did trough in the very week in which Laffer probably drew the napkin, the chance that the two were linked, in a causal relationship, is not negligible. Ford became president on Nixon’s resignation in August. In September, he convened an economic “summit conference” in Washington. Major economists joined a bipartisan group from Congress for a big think on how to respond to the vexing conditions. The Public Broadcasting Service carried the meeting on television. Any number of ideas emerged from the group. Several in particular swayed Ford. He would fight inflation by means of persuasion, as well as a high-income tax surcharge, and recession with a tax rebate targeted at low earners. In a televised address in Washington, wearing a red “WIN” button standing for “Whip Inflation Now,” Ford outlined his ideas and asked Americans to do such things as grow more food (it was harvest season), walk instead of drive, and sport an inflation-fighting attitude. The Democrats drubbed the Republicans in the midterm elections four weeks later. In the wake of this rout, which Ford had intimated he knew was coming in his WIN address, the stock market skidded downward, losing 14 percent from election day to December 6, White House staff scrambled for new ideas, and Cheney met Wanniski and Laffer at the Two Continents. The second week of December, on the 11th, Wanniski published a piece in the Journal based on an interview he had done with Mundell. It was his belief, as he later noted, that it was “the tightest exposition of the model I’ve ever written.” One of the reasons, he confirmed, was that Mundell had double-checked every word. The piece was called “It’s Time To Cut Taxes.” In place of the Ford tax increase, there should be monetary restraint—Mundell’s preference since 1971—and a “$30 billion” tax cut. Measuring tax rates by total amount of dollars—“$30 billion”—was a Keynesian practice. It meant, presumably, the difference in the amount of taxes that would have to be paid, under static analysis, before and after the



tax cut. Mundell had a Keynesian side—his models of the 1960s strongly implied that government spending is stimulating. Using “$30 billion” was a mark of Mundell’s. So was Wanniski’s explanation that the tax cut would “draw money from abroad.” There were crypto Laffer signals as well.1 “It’s Time To Cut Taxes” noted explicitly that “with Professor Arthur B. Laffer of the University of Chicago,” Mundell “has worked out an economic model to deal with this problem,” that of the big inflation. In addition was this passage: “A tax cut not only increases demand, but increases the incentive to produce.” Then quoting Mundell, “The government budget recycles tax dollars into the spending stream through expenditures, but in so doing it reduces the incentive to produce and lowers total production. After all, if total taxes and expenditures become confiscatory, all economic activity would cease and the government tax bite would be 100% of nothing.” Confiscatory taxes culling 100 percent of nothing is the terminal point of the Laffer curve. Specifically, it is the terminal point of the one Wanniski would draw in The Way the World Works, with magnitudes on the y-axis ranging from zero to 100 percent. In Laffer’s notes, there were no magnitudes (aside from the implied zero at the intersection of the axes), and the ao variable meant that there was some minimum of work that continued beyond 100 percent taxation. Another point that Wanniski offered of Mundell’s was that absent a tax cut, “tax revenues of state, local, and federal governments will decline.” The total tax take— reminiscent of Laffer’s TTr—of all governments within the United States, given a federal tax regime, was, at the time, a regular topic in tax-policy discussions. An impetus for the John F. Kennedy tax cut of 1963–64 was the recommendation from representatives of state and local governments that a federal tax cut would occasion growth and therefore tax receipts at their level. The criterion of the Laffer curve, as Laffer had recently drawn it, was “total tax revenues.” These conceivably could even include all tax revenues within the world economy, if the taxes of the taxing authority in question affect transactions globally.2 There are suggestions in this article that Wanniski had been exposed recently to the Laffer curve and was in the process of digesting its meaning and implications. That he mentioned Laffer in this article but did not mention the curve (or the napkin), given that the Two Continents meeting must have just recently happened, prompts the conclusion that it took Wanniski some time to settle on the final decisive importance of the Laffer curve. It was on reflection that Wanniski came to realize that the Laffer curve was the key to launching and leveraging the supply-side revolution.



This much is clear from Wanniski’s writing in late 1974 and early 1975 and waiting until 1978 to publicize the curve. Moreover, the combination of the Laffer curve napkin episode’s having probably taken place at that time, with the publication of “It’s Time To Cut Taxes” shortly thereafter, adds to the correspondence of these events with the trough of the stock market. To make such a connection is perhaps at first glance irresponsible. However, several points of justification are in order. The first is that a necessary condition of causation is temporal proximity and correlation. In this case, there was temporal proximity—in December 1974 came these Laffer-­Mundell events as well as the trough of the long stagflation market. And there was correlation—the curve on a napkin and the Wanniski article were outriders of the coming Reagan tax policy whose implementation tracked the great stock take-off of the early 1980s. In the second place, stock-market behavior reflects pan-human apperception that has no natural correspondence to, and bears no responsibility toward, received opinion of the professional and official variety. The market can embrace “crank” views because of the supremacy of its decision-making authority. It can decide whatever it wants without feeling social pressure. James Carville testified to this reality in his remark in 1993 that he wanted to be reincarnated as the bond market, because then he could intimidate everybody. A history of modern historical troughs in the market can, indeed, be suggestive of the market’s intuitive interest in reading conditions on its own, regardless of official opinion. The double-trough of the Great Depression years, of 1932 and 1938, for example, corresponded in the first place to the assurance that Herbert Hoover would no longer be president and in the second, that President Franklin D. Roosevelt had at last gone too far (with tax increases and court packing, etc.) and that the New Deal had met its maximum extent. The trough of November 1994 corresponded to the day to the Republican takeover of the House of Representatives, the first Republican House in forty years. As the summer 2007 peak timed the coming of Barack Obama, the March 2009 trough correlated to an assessment of what this presidency actually would amount to. Any number of these conclusions may fall outside of the boundaries of received opinion and politesse. That, however, is specifically the prerogative the market has. No bar restricts it from acting on the silent thoughts of its collective consciousness, and its unstated preference is probably to act instantaneously on information. The evidence exists that the



stagflation market may well have perceived in the doings of Laffer, Mundell, and Wanniski late in 1974 that “the recuperative powers of this great nation,” as Bartley later put it regarding the first inklings of the recovery that ultimately came, had begun to operate.3 It is in such phenomena that the costs of the armchair evaluations that can characterize interpretations of the supply-side revolution come into focus. Popular historian Rick Perlstein derided Wanniski’s article for asserting that its effects would be immediate. Perlstein wrote in Reaganland (2020), using italics satirically and quoting the article, “however, with the ‘announcement’—merely the announcement—‘of a major tax cut,’ this economic desert would bloom: ‘the capital market would instantly’— instantly—‘perceive that it is more profitable to do business in the United States than the rest of the world.’” The curious point is that Wanniski may well have been right. His article functioned as the announcement—and the market found the trough with it, incorporating the sliver of information in the moment. The historical process is a given, as hard and fixed as any in science. Mocking Laffer and Wanniski can make for good sport in café society. But it runs the risk of jeopardizing historical understanding of a problem no less than the major economic crisis intervening between the Great Depression of the 1930s and the Great Recession of the following century.4 Several months later, the spring 1975 issue of The Public Interest, Irving Kristol’s journal and the center of the rising neo-conservative movement, published an extended treatment of Wanniski’s of “The Mundell-Laffer Hypothesis,” as this article was called. It was a compendium of the thoughts Laffer had been offering on the Journal editorial page over the last two years, plus a digest of Mundell’s views as Wanniski had learned them in conversation with Mundell during his first year in New York at Columbia. The article appeared alongside others written by the founding figures of academic neo-conservatism: the Harvard sociologist Nathan Glazer, critic of the Great Society; his Harvard colleague political scientist James Q.  Wilson, elucidator of “broken-windows” policing; and Yale drug-policy scholar David Musto. The Public Interest encapsulated the concern among certain right-leaning figures across the academic disciplines, in the mid-1970s, about the current system of disseminating useful scholarly ideas. Kristol’s magazine strove not so much to popularize useful research from the academic journals for a broader intellectual and policy audience. Rather its point was to give a platform to increasingly conservative scholars to whose ideas the journals were becoming cool. In the issue



in which Wanniski published in 1975, another non-academic providing an article, on “The Social Pork Barrel” concerning government spending, was David A. Stockman, the future OMB director under Reagan and, after his turn against tax cuts, the bête noire of that administration. “The Mundell-Laffer Hypothesis” began with an assessment that was inescapable by the spring of 1975. This was that “the United States has been passing through an economic nightmare.” It was an interesting choice of metaphor. A nightmare is temporary. Before and after the nightmare, when one is awake, one is ordinarily in a more pleasant state of consciousness. As the article suggested, Wanniski was in accord with Mundell and Laffer that the economic problems the United States was experiencing were unnatural and therefore in essence temporary. President Ford had used the term the previous summer on assuming office, saying of Watergate that “our long national nightmare is over.” Wanniski was tipping off the belief, central to Mundell and Laffer’s economics, that, as Mundell had said in 1971, “there are no economic costs” to correcting the policy mix. Noninflationary growth would come immediately with the implementation of tax cuts and a reinstitution of classical monetary norms. This was a challenge to Keynesianism, given the Phillips-curve trade-off, and certainly to monetarism. Its standard hedges of “gradualism” and “long and variable lags” met a match in “no economic costs.”5 The article, however, was as its title said. It described a hypothesis as opposed to presented and recommended a plan of action. The bearing Wanniski would adopt in in 1978 in The Way the World Works was not yet ready to be adopted. In that book, Wanniski exuded an implacable confidence about “how economies fail—and succeed,” as in the subtitle, and as described by Laffer and Mundell with a dose of Wanniski’s own “political model” explaining the electorate’s ability to detect best policies. In the 1975 Public Interest article, Wanniski was in a humbler vein, offering Mundell and Laffer’s views with a clear earnestness but only offering them all the same. He went into Laffer’s point about how inflation comes to a devaluing country in equal measure, citing the research of Laffer’s student, Moon Hoe Lee, which had impressed Fischer Black. He expressed Mundell’s aphorism that Bartley would incorporate into the Seven Fat Years, “the only closed economy…is the world economy.” And he went on about how the usual “economic doctors of Cambridge and Chicago” have perhaps been making the “patient”—the economy—“sicker than he was.”



In a footnote late in the article, Wanniski detailed the Laffer curve without naming it as such. “There are always two tax rates that produce the same dollar revenues,” he quoted Laffer. Wanniski went on, “if the tax rate were below the rate that maximizes revenues, tax cuts would reduce tax revenues at full employment. But…the tax cut then raises output and the tax base….Even if a bigger deficit emerges, sufficient tax revenues will be recovered to pay the interest on government bonds issued to finance the deficit….Tax cuts, therefore, actually can provide a means for servicing the public debt.” It was an early identification of the Laffer curve, without name, without napkin, without use of the word “curve.” It was an early understanding of it too, omitting parts of Laffer’s model showing that as the time periods go out as rate-changes hold, the fullness of the revenue-­ responsiveness emerges. Wanniski’s words in the footnote are evidence that the napkin incident happened before early 1975, if it was Wanniski’s belief, expressed later, that the back of the napkin represented the “first time” Laffer drew his curve. They also indicate that Wanniski had not yet come to believe that the Laffer curve was a uniquely winning idea. As of this point, he was burying it in a footnote. For now, as he put it to close of Mundell and Laffer, and even as stagflation raged, “theirs may or may not be the ‘Copernican revolution’ in economics that is needed. But at the very least, one suspects, it can legitimately claim a proto-Copernican status.”

Policy In the article, Wanniski quoted an extended section of an “Economic Reform Program” which Laffer had submitted in November to treasury secretary Simon at his behest. This paper of Laffer’s was an outline of the policy mix that Mundell had suggested in 1971, of monetary restraint and tax-rate cuts. It was the first of a number of works that Laffer would produce over the next two years submitted not to journals or publishers but to public officials in the interest of influencing policy. His circle of influence included Simon (Shultz’s successor at Treasury), Rumsfeld and Cheney in the Executive Office of the President, and various Members of Congress who called on him for committee testimony.6 The Economic Reform Program was chiefly concerned with inflation. This was the problem that had exercised the new Ford administration and whose initial efforts at dealing with it—the summit and the national television address—met the bad Republican losses in the November mid-term



elections. Laffer agreed, in the paper, with the “cliché” that “too much money chasing too few goods” causes inflation. Arguably, the cliché did not capture his view. Laffer had been holding that devaluation disturbs the relative price structure, which automatically calls for the collateral result of inflation. In such a sequence of events, there is no primary significance to an increase in the monetary float. Laffer may have shelved explaining that idea in this paper in order to dispense with preliminaries with Simon and focus on policy prescriptions. He probably also believed that in all, there could be many causes of inflation. Laffer recommended to Simon a reestablishment of fixed exchange rates. He allowed for this to proceed under the auspices of the International Monetary Fund and included a provision, not spelled out, of regulating Eurodollars, or those dollars held abroad not subject to Federal Reserve supervision. The monetary part of the paper was rather brief, however, even as the subject of inflation did not change. The remaining portion was largely devoted to the issue that Mundell would raise with Wanniski: “to stop inflation you need more goods, not less.” Laffer delved into how to solve the unemployment problem. With jobs and growth, he implied, the endogenous nature of monetary creation would reassert itself and align what money existed in the economy with what the economy actually required for the purposes of transactions, investment, and saving. He detailed to Simon his theories about the wedge. Laffer wrote that “the best program to combat inflation…increases output growth.” He then noted a “simple truth.” This was that “in part productive factors’ choice to work is based on their ability to earn after-tax income [and] that the more an employer has to pay his factors of production the less he will want.” Laffer specified where he was going: “Marginal tax rates of all sorts stand as a wedge between what an employer pays his factors of production and what they ultimately receive in after-tax income.” This was one of the first times Laffer (or Mundell) strongly identified the need for a marginal tax-rate cut. Mundell had come close in 1971, when in “The Dollar and the Policy Mix” he emphasized that the tax cuts that he recommended had to take into account that “the United States does not have inflation-immune tax structures.” However, a Keynesianism lingered in Mundell’s theories about the instrument of fiscal ease. In his interviews with Wanniski, which were consistent with his economics of the previous decades, Mundell held that fiscal ease taking the form of any sort of tax cut would increase the incentive to produce as well as the demand for money. Tax cuts such as new rebates, deductions, or exemptions would



occasion a process akin to that of the Keynesian multiplier in stimulating supply. With Laffer’s notes on the Harberger triangles—on the wedge—the die was cast for marginal tax cuts. Laffer was now showing that on the matter of “to stop inflation, you need more goods, not less,” the point of attack had to be at the point of production. A decision to employ or to take employment depended on the last rates of taxation faced by the two parties on a marginal scale. If employer and employee could contract at $10, but $10 meant $11 after taxes for the employer and $9 for the worker (as in the example Wanniski drew from this paper of Laffer’s in the Public Interest article), there would be no agreement. A tax rebate would not spur the worker calling for $10 to take less in wages. A rebate would have no effect on the employer as well as leave the worker with the same wage-­ tax frontier. The kind of tax cuts that would spur production were marginal. As Laffer put it to Simon, “these reductions will be most effective where they lower marginal rates the most.” In the next section, he showed that capital taxation—whose rates had increased wildly in real terms given the inflation—was a particularly effective area for output-enhancing marginal tax cuts. The form he recommended here and elsewhere was indexing the tax code for inflation. Laffer reserved particular scorn in the paper for one particular category of spending, which he insisted had to be reduced as tax cuts came along. This was “transfer spending.” Tipped off by their OMB model, which showed transfer spending correlating to GNP declines, Laffer and Ranson had followed up in their 1973 research on the growth implications of social security and made use of the term “wedge.” In 1974, having made progress on his comprehensive wedge model of the economy, Laffer wanted to attack the wedge on multiple fronts. First and foremost on the tax side, he wanted wedges recognized for what they were and reduced or eliminated. Second, he wanted transfer payments curtailed to reduce the effective demand for government programs such as social security whose taxes caused the wedge in its clearest expression. To close the paper, Laffer returned to monetary arguments. He advocated a return to a gold-defined dollar and explained why. Consistent with his devaluation-inflation arguments, he noted to Simon the need “to fix the price of a single commodity.” If one major price is fixed—if the dollar is redeemable in that commodity at a par—then the relative price structure will not change care of monetary policy. This was the argument he had been forwarding ever since the 1971–73 devaluations. Given flexibility, as



exports become cheaper (and imports more expensive) with a devaluation, the entire relative price structure of the economy has to adjust to reassert itself into its pre-devaluation form. This manifests itself as a leap in the price level such that the more expensive imports are now no longer more expensive and the cheaper exports no longer cheaper. By fixing only one price in the economy, that of gold, monetary authorities steer clear of disturbing the relative price structure. Disturbing this structure was the very mechanism of inflation—therefore returning to a gold dollar was the solution to the great economic problem of the day. With respect to implementation, Laffer advised a near total sale of the US gold stock, a dispensing with all targeting of monetary aggregates, and directed that authorities such as Simon “should establish an official price of gold and support that price for all buyers and sellers. The price of gold should be controlled not by maintaining vast inventories which fluctuate”—the core of the Triffin dilemma—“but by regulating the world’s quantity of money so as to stabilize the dollar price of gold. By doing this monetary policy is assured of neither being excessively expansive or contractionary.” These words were similar to those he had proposed to Shultz in previous years and found final fulfillment in Laffer’s 1980 paper, “The Reinstatement of the Dollar: The Blueprint.” Laffer was calling for the system Mundell had interpreted the French as bidding for in 1967–68.7 Bretton Woods blessed the system that had begun with Roosevelt’s gold confiscation of 1933. That move was an early expression of the idea— first explored by Great Britain after World War I—that the major economic hegemon should have a surpassingly large gold stock. Prior to that war, having a very large national gold stock was a characteristic of countries, such as Imperial Russia, issuing possibly dodgy currency. Having a gold stock notable for its size in the years of the industrial revolution was a signal of lack of confidence in one’s currency. If an issuer is sure to redeem at any time given the massing of gold collateral, how much confidence is there in that currency as a ready medium for transactions and safety in the marketplace? After 1933, the foreign gold flows into the official United States hoard as World War II progressively unfolded redoubled the effect of the confiscation and its offspring, Fort Knox. Two decades later, France apprehended, per Mundell’s interpretation, the unnaturalness of the whole setup. Gold should be both the basis of the global monetary system and diffuse among holders public and private. The proper point of Bretton Woods was to assist in evolving the world monetary system back into the



status quo ante of the pre-World War I years, the Belle Époque. Instead what came was the fiat dollar, malaise, and the phenomenon of worldwide inflation. In reflecting on his long friendship with Milton Friedman, Laffer has expressed, along with admiration for Friedman’s originality and argumentative acumen (and tenacity), his belief that the function of monetarism within the development of economic thought was not so much to hold up fundamental new insights about money as simply to challenge Keynesianism. That was its central purpose and point of origin. One cannot fight something with nothing. It was a club to beat down Keynesianism. Keynesianism set store in, first, the inevitability of the liquidity trap under the conditions of late capitalism and, second, the fiscal multiplier as the only way out. The specific genius of monetarism was to identify non-fiscal, non-real causes of economic variations in the management of the money supply—and thereby provide an alternative to Keynesianism for which it had no direct reply. They became two systems shouting at each other, one on the fiscal and the other on the monetary side. There may have been attempts to incorporate the two—the essence of the vogue of the Phillips curve—but monetarism accomplished its goal. It distracted, if not immobilized, Keynesianism by forcing to the center an issue, money, that Keynesianism’s own systematics could only regard as secondary. From this perspective, the great prospering of the world economy through the 1960s, as Mundell remarked upon to Congress in 1965, derived from the neutralization of the bid for hegemony among the major schools of economic theory. Keynesianism and monetarism were fighting each other, all while a simulacrum of the monetary system of the Belle Époque, Bretton Woods, proceeded apace. There were even non-­Keynesian marginal tax cuts, above all those produced by President Kennedy’s legislation of 1963. The economy prospered because modern theory was at loggerheads. By the 1970s, however, that body of theory had found a way to reassert itself. The incessant carping in the Triffin vein for a dozen years through 1971 did its part in encouraging a sense of crisis. Perhaps in the power play between France and the United States the Americans did not want to concede. But as Mundell noted, the French had a point. Bretton Woods was a highly useful expedient that organically should have given way to world money once again. The loss of American gold was actually a sign of Bretton Woods’ working. The basis of a deep global market in gold was developing. In Laffer’s view as of the mid-1970s, like that of the



French of the late 1960s, widely diffused gold remained in reach as a policy option to ground the world monetary system. In the “Mundell-Laffer Hypothesis,” Wanniski quoted Laffer, “nobody’s thought much about it this way for about 50 years or so.” The “50 years” was telling. Fifty years prior was the 1920s, before the Keynesian revolution and the monetarist counter-attack. Wanniski and Bartley both noted Laffer’s affinity to classical French political economist Jean-Baptiste Say. Bartley recorded Laffer’s telling him at Michael 1 of Say’s Law, “That’s what I believe in,” and “that’s what you believe in too.” Keynes’s General Theory of 1936 set up as its premise, in its prefaces and introduction, the repudiation of Say’s Law. Keynes’s summary of it as “supply creates its own demand” in these pages was arguably a straw man. Keynes himself appears to have appreciated this in his near-apology in the preface he wrote for the French edition of the book. Risking more exaggeration in his characterization of Say, perhaps in the interest of flattering French sensibilities, he wrote that “economics everywhere up to recent times has been dominated…by the doctrines associated with the name J.-B. Say.” But even as the defining purpose of the book, as he wrote further in the apologetic vein, was to elicit a “final break away from the doctrines of J.B. Say” as goes a theory of production, in compensation he was reviving the theory of interest of Montesquieu, who was “the real French equivalent of Adam Smith.”8 Montesquieu could just as easily be hauled in to justify the gold standard, as discussed in Chap. 4. At any rate, Laffer was contending, via his wedge and ultimately curve analysis, that he saw what counted at the point of decision-making about proceeding with production. This had been the preoccupation of Say, who felt that entrepreneurs have a way of seeing the latent spending priorities of the marketplace. The tagline “supply creates its own demand” does not capture the meaning here. An entrepreneur of the Say type comprehends what the market needs, but does not have, and as well what price the new good or service might command. This necessarily visionary entrepreneur, per Peter Drucker in the twentieth century, then proceeds with production on a “price-driven costing” basis, aligning the costs of inputs with a taken price. This is where the wedge becomes fatal to the process of proceeding with production. The visionary sees the latent demand and the price point and the margin. But then wedge comes in to gobble up the margin and make the endeavor a losing one.9 In understanding monetarism and Keynesianism together as an episode in professional competition, Laffer implied that the preoccupation of



bludgeoning each other, on the part of the numerous high theoreticians, in their august academic chairs which fostered a false sense of importance, allowed the economy to proceed without the services of either one of these theories. It was a nice trick that the cunning of reason played on the economists. All the while, there was a classical-like monetary system and a huge demobilization out of government spending globally within the industrialized countries after 1945. Where that process was least pronounced, in Great Britain, the growth rate was the slowest. Meanwhile, with all their publications in the likes of the sonorous AER, QJE, and JPE, and their appointments reeking with prestige, the Keynesian and monetarist heavyweights in the field thought they were relevant. They only became relevant once again with 1971. It was time, therefore, for the cunning of reason to mount its counter-­ attack. It was time for an overt reassertion of Say’s Law. The reassertion since 1945 had been covert. Economics got wise about having been fooled, and the monetarists joined forces with the Keynesians and reclaimed the mantle of policy influence. On came floating rates, freeing up exclusive focus on the supply of money as opposed to its price, the demand of monetarism. There was peacetime government spending, a full-employment budget no less, and by virtue of the bracket creep resulting from the inflation caused by the floating rates, a structure of tax increases on those prone to the liquidity trap, the affluent. At last monetarism and Keynesianism were cooperating. Monetarism had come into being as a competitor in a mano-a-mano Olympic intellectual contest. After the performance of the battle, the mutual respect established, the titans joined forces against their common foe who had been greatly at play while their contest raged: a self-regulated prospering world not much in need of a massive profession of economists. When Wanniski wondered if “the economic doctors of Cambridge and Chicago” were not making the patient sicker, he put his finger on the narrow self-interest that obtained in the onset of stagflation. A prospering economy is a self-confident one. If economists want to take the credit, a well-off society in its bounteousness will grant it. Yet the credit given to economists in such a context—the reductio ad absurdum being the Kennedy CEA—is not a testament to the credit they actually deserve. It is evidence of how prosperity breeds a big-hearted people. As James Tobin’s reflections somehow give away, there was something unsettled about the New Economists, some meanness on their part that was not going to stand for a boom of noninflationary economic growth that could really



render economists insignificant and ornamental. All Tobin’s talk of the “extraneous taboos,” the “ancient ideological obstacles,” and “a wave of resentment and distrust of government and academic economists, especially strong in the business community,” had a note of animus against those economic leaders (namely businesspeople) who were not economists and did not defer to economists. The 1970s had to happen for economics. So the field made them happen.10 These high practitioners in the discipline perhaps did not realize that in not fighting fair—and abridging the great post-World War II prosperity was not to fight fair—the adversaries respond in kind, and with full justification. The cunning of reason presented the high practitioners with a new adversary: the crank. Initially they deigned not compete, requiring an adversary befitting their station. But that was not an option—the battle had to be joined—and in the event the provenance of the adversary muddied the matter. Only recently, Laffer and Mundell had been among the hottest things in the field. Mundell had “dominated international trade theory in the 1960s,” as Stigler wrote in 1978, “but has apparently stopped working.” Laffer was initially a Wunderkind, but once falling in with Nixon stood revealed as the enthusiast who forgot to get his Ph.D. Economics had to brush aside or face down these adversaries—or deal with the world they were keen on creating, surely at the expense of the profession.11 Laffer pushed on with policy work. Congressional testimony became a forte. In 1975 and 1976, he gave a number of presentations to the Joint Economic Committee in particular, picking up a skeptical interlocutor in its sometime chair, Rep. Reuss of Wisconsin and catching the eye of Texas Sen. Lloyd Bentsen. He gave testimony on the currency system. His main points were those he had adumbrated in the journals. Fixed rates democratize the supply of money globally and relieve the Federal Reserve of the impossible burden of being right. Devaluations require inflation because of the strong staying power of the relative price structure owing to efficient global markets. The world was getting exasperated with the floating-­ rate experiment and was looking for American leadership out of the morass. He made these arguments with his usual apparent enthusiasm, but the heart of his economics nonetheless seemed to be moving elsewhere. Fischer Black’s sequestering in the field of finance, as opposed to economics, was a strategic coup for the fortunes of monetarism. Black’s forbiddingly clear mathematics on the endogeneity of the money supply, were Black a top economist per se, would have hampered the



advancement of a school of economics stressing the imperativeness of counting and monitoring the money supply. Endogeneity implies that the money supply is self-regulating. As Black’s biographer Perry Mehrling has written, from Black’s “point of view, the dispute between the monetarists and Keynesians was largely irrelevant, because in a modern credit economy the central bank must be largely irrelevant.” In time, “the end result was that Chicago became famous for two different alternatives to Keynesian orthodoxy: Friedman’s quantity theory of money in the economics department, and Fischer Black’s efficient markets theory of money in the Graduate School of Business.” Initially, “a revival of the banking school approach to money”—endogeneity in the modern parlance—“cannot have seemed destined for much success….The pace of evolution toward Fischer’s simpler world was slower than Fischer anticipated, for the very good reason that it takes time to learn new ways….”12 Black’s clarification of the algebraic necessity of endogeneity confirmed the main argument in Laffer’s currency economics of the late 1960s and early 1970s. The question left was the mechanics of endogeneity. What made people demand money? In working out the wedge model, inclusive of the tax-rate/tax-revenue two-solution curve prefigured in Black’s work on the course of the price level under activist monetary policy, Laffer was zeroing in on the wellspring of endogeneity. Monetary demand, and hence supply, turned on the decision to produce. It turned on the decision to employ capital and labor, and for labor to apply itself for remuneration. In testimony against the Humphrey-Hawkins Act of 1976, which envisioned providing the unemployed with government jobs, Laffer conceded that “there is no economic issue more important now…than relieving unemployment.” He added that “the plight rendered by unemployment is abominable to the wage earner and his family. The market failure to make use of a perishable natural resource makes us all poorer.” A lagging indicator, unemployment was staying high a year after the 1973–75 recession even as inflation had broken a bit. In 1975, Ford had not gone through with his high-income tax surcharge but instead opted for a small tax rebate (neither of which was in accord with the napkin sketch Cheney had beheld). Now in May of the election year, unemployment stood as last reported at 7.7 percent, down from a painful 9 percent the previous May. Inflation for the year was currently making a relative pause, holding at a yearly rate over the first five months of 1976 at 4 percent.13



In his testimony, Laffer used a line that became one of his signatures, offering it in upcoming years to Ronald Reagan many times: “If taxes on a product are raised there will be less of that product.” It included this rider: “Likewise, if subsidies for a product are increased, in general, there will be more of the now subsidized product.” Laffer indicated that these axioms fully applied to the matter of employment. “In the United States today,” he put it in his prepared remarks, “we are taxing employment through a multitude of taxes such as personal and corporate income taxes.” He observed that “a firm’s decision to hire is based, in part, upon the total cost to the firm of the employee’s services.” And “employees’ decisions to work are also, in part, based upon the amount of earnings the employee himself gets….Employees, it should be noted, do not concern themselves with the total cost to the firm. All employees care about is how much they get, net.” As for his contribution to this theory, “in sum, firms worry about the total wages they have to pay, while employees are concerned with the wages they receive. The difference…is called the ‘wedge.’ This ‘wedge’ consists of income taxes, payroll taxes, excises, sales taxes, property taxes as well as the market value of the accountants and lawyers firms hire” to be in compliance with government mandates. He offered his example of a firm wanting to contract with a prospective employee, and vice-versa, at a certain rate, but the addition of the wedge makes both firm and prospective employee walk away. Laffer went so far as to account the gross wedge in the United States as “either total government spending or…transfer payments.” Drawing on the conclusions he had reached from the OMB model, he testified that “basically, transfer payments are real resource transfers from producers and workers to people based upon some characteristic other than work or production. As such transfer payments reduce the amount of goods and services available to people who produced them.” These comments were not alien to the work of Paul Baran (and Paul Sweezy) and suggested as well that Keynesianism had misdiagnosed the problem of the liquidity trap. The wedge removes a percentage of profit from the producers of goods and services and transfers it elsewhere. Therefore, there will be less commitment of resources to, and investment in, the production of goods and services. Baran was concerned with the matter of how much growth is possible on clearing out non-productive accretions in the economy. Chiefly, in his view, these concerned the methods business executives employed to corral corporate revenue for themselves, from milking expense accounts to running up government



contracts. Laffer was prepared to put things of this nature (expense accounts being highly valuable thanks to their deductibility in a high marginal tax-rate structure) into his wedge. The liquidity trap, in the era of big government, was not that at all. There would be greater commitment of capital on the part of even the settled rich if production could proceed at the price point upon which owners and workers actually wished to agree. Laffer offered numbers. He presented a time series of the wedge that had it as high as 48 percent of GDP in 1975, up twenty points from the 1950s. One could mistake the table as coming out of Sweezy and Baran’s Monopoly Capital (1966). That work had numerous lists of indicators of the “surplus,” or economic production beyond subsistence goods that, the authors felt, generally went captured into frivolous consumption and pocketing by executives, as opposed to being divided into shrewd investment and spare intelligent consumption. One of their charts was a time series of the surplus in the thirty-five years to 1963. As a percentage of GNP, it trended upward from around 48 to 55 percent over the interval.14 Laffer’s wedge time series was but a step away from this chart. Its amalgam of government spending and transfer payments strove to show what could happen in terms of real growth if only the United States cleared out impediments to production. Sweezy and Baran detested advertising, expense accounts, and government contracts, finding them to siphon off resources that could be put to good use specifically in real investment. Laffer scorned government spending and particularly transfer payments, finding them to impose costs on the productive process that could only depress investment and the decision to work. “The general tendency…has been to make the economy less efficient,” as Laffer testified. As Sweezy and Baran wrote of (tax-preferred) corporate perquisite spending, “most of this is the sheerest kind of conspicuous waste, correlated negatively, if at all, with productive efficiency.”15 Laffer’s recommendation to Congress was to retire the Humphrey-­ Hawkins bill (it would become law in 1978). In its place Laffer made what would become his signature proposal. “What must be done…is to reduce the tax wedge on producers and workers….It is especially important for the reductions to be on marginal rates of taxation.” By cutting the marginal corporate or personal income, or social security or capital gains tax rate, more of the amount paid at the margin for workers and capital would result in payment received by the worker and a return for the owner of capital. A non-marginal tax cut would not disturb the wedge. A rebate would add mainly to “permanent income,” along Friedman’s definition,



affecting barely at all the decision to produce more in the moment. Any tax cut leaving marginal rates intact would leave employer and employee, and the prospective owner of capital, facing the same rate of taxation at the point of the wedge. Laffer’s extended comments before the committee met occasional interruption by Democratic Sen. Gaylord Nelson of Wisconsin. In general, Laffer testified away in the committee room, heedless of the hard free-market drive of his views. “Today in the United States I believe we are basically taxing work, employment, and are subsidizing inefficiencies, nonwork, and nonproduction. It should come as no surprise to us here that in fact the United States does have an employment problem,” as he said. “The resources taken by the Government are taken from workers and producers….The fundamental measure of the wedge is total Government spending….As far as I can tell from this bill [it] will, if implemented, increase the wedge in the United States….It should come as no surprise to us that we have just had one of the worst postwar recessions. It came at just that time when Government spending was the greatest and was geared most closely to the level of unemployment.” He said all these things in the committee room of Congress. His chief recommendation was a corporate tax-rate cut. As of the middle of 1976, Laffer was still an expert indulged as such in the halls of power. However, his commentary had taken a dedicated turn, if one based on rather extensive model-building (inclusive of the Laffer curve) toward forwarding fiscal ideas that he had not yet aired in the journals. Up to this point, he had largely confined his policy remarks to the monetary theory by which he had already made a name for himself in the journals. There was the OMB model, but the talk over that came less from Laffer himself than from the commentariat at large and, when it had to be defended in Congress, Shultz. Laffer was now tipping off that he was becoming interested in taking his ideas first not to the journals, the conferences, or a workshop, but to the forums of the public.

Waning in Academia If Stigler thought Mundell had “stopped working”—as in not publishing further original research in the journals—something similar was happening to Laffer. He had not stopped working by a long shot. But unlike in his scholarly Wunderkind period prior to the OMB stint, the work he submitted was now getting the treatment in review and not getting



accepted. In the economics journals, aside from the work he had prepared largely before 1971 and published subsequently, his new submissions resulted in only two successes, both co-authored. In 1975, the Journal of Monetary Economics published a study of interest rates he did with his Chicago colleague Richard Zecher. And in 1978, Kyklos published an article he co-authored with his former student Tamir Agmon, on the intensely relevant topic of oil prices. Otherwise he tried and failed with his submissions to the high organs of economics. The chief exhibit was his attempt to rework his celebrated (in manuscript) “Anti-Traditional Theory of the Balance of Payments Under Fixed Exchange Rates” paper of 1969 whose revisions he astoundingly had not completed after its acceptance at the AER. During the Ph.D. flap in the spring of 1971, Laffer told Stigler that this was a mistake and he would try to correct it. The problem was that events were rapidly passing the paper by. Fixed exchange rates were a dead letter as of early 1973. The balance of payments—that vogue of the 1960s—became yesterday’s news. As Wanniski wrote in the Journal in 1974, at least there was consensus among economists and policymakers, as stagflation came on, that thanks to flexible rates they did not have to worry about the balance of payments anymore. Laffer was there on the spot with his “Anti-­ Traditional” paper in 1969. But he dallied on acting to publish, and the propitiousness passed. In early 1974, Laffer completed a paper along the lines of “An Anti-­ Traditional Theory” that corresponded to the new policy conditions. It was called “Exchange Rates, the Terms of Trade, and the Trade Balance.” It was an attempt to forward the arguments of “An Anti-Traditional Theory” in a world of floating rates. The original model, in “An Anti-­ Traditional Theory,” had no applicability outside of fixed rates. Fixed rates were an assumption. In the new paper, he began as Mundell had in 1966 and he had in 1969: “One need not search far to find numerous statements describing the relationship between a country’s exchange rate and its trade balance.” Usually one expects “an improvement in the devaluing country’s trade balance….In this paper I question this presumption.” The paper was joining the battles of the late 1960s in the changed terms of the 1970s. It proceeded to elaborate a model of the points he had been making in the Wall Street Journal, such as that export goods on becoming cheaper care of a devaluation should be more consumed at home. The paper also formalized an extended series of memos he had written while on duty to Shultz called “Stylized Fallacies of International Trade.” These



were twenty-one in number. Representative samples were “the need for international reserves would be greatly reduced by a system of flexible exchange rates,” “there is a serious need for more world reserves,” and “the U.S. has been, and is, living beyond its means.”16 Laffer sent his paper to the AER for consideration. His former great advocate, managing editor George Borts, could not muster enthusiasm for it. Borts had been approving Laffer’s work with Fama that had come out in his journal in recent years, but he rebuffed this new work. He wrote to Laffer a rejection, putting it directly that “the referee’s reaction was the same as mine….Seriously this is a nonpaper. If there is a message, two very good balance of payments types have missed it.” Returning to comity, he said that he was looking forward to the AEI inflation conference that Laffer was putting together. Laffer reworked the paper under a new title, “The Trade Balance and Economic Activity,” and got another negative from the AER. It was telling that Borts noted that “two very good balance of payments types”—he and the reviewer—had passed on the paper. Balance-of-payments types as of 1974 had realized that their heyday had passed. They were not going to continue to indulge work that rehashed the debates of the 1960s, if updated for the 1970s. It would be detrimental to their relevance, sticking with passé causes. Laffer had had his chance with his anti-traditional arguments in the AER in 1969.17 All the same, the “Anti-Traditional” paper itself had a swell of influence in the mid-1970s. Even as it had only been presented in manuscript, it was one of the pillars of a new timely school—a new vogue—of trade theory under flexible rates. This school, this “small but influential group of international economists [that] has stood traditional balance-of-payments analysis on its head,” as economist Marina von Neumann Whitman put it at a Brookings conference in 1975, attracted a name for what it was doing. It pursued “the monetary approach to the balance of payments.” Its initial elaborator and in time full-throated advocate was Laffer’s Chicago economics colleague Harry Johnson.18 In a lecture in Switzerland in February 1971, published in the Journal of Financial and Quantitative Analysis the following year, Johnson was the first to identify the school as such, in an article called “The Monetary Approach to Balance-of-Payments Theory.” He wrote of his “purpose in this paper…to outline a new approach to the balance of payments…that has been emerging in recent years from several sources.” He mentioned several dating back to the 1930s and noted that “the new approach is also evident in the theoretical work of my colleagues at the University of



Chicago, and R.A. Mundell and his students, although it is only fair to note that economists elsewhere have been working along similar lines. The essence of this new approach is to put at the forefront of analysis the monetary rather than the relative price aspects of international adjustment.”19 Johnson described the Keynesian—the “standard”—model in which demand management within a country determines the amount of investment and consumption at a given exchange rate. By choosing a demand-­ management policy and an exchange rate via economic wisdom, “the authorities can obtain full employment consistent with any current account surplus or deficit.” Name an exchange rate, and Keynesian policymakers can adjust taxes, spending, and interest rates within the domestic policy that yields full employment without occasioning international disequilibrium. Domestic authorities can get it done. “The new approach,” however, “assumes—in some cases, asserts—that…monetary inflows or outflows associated with surpluses or deficits are not sterilized,” which was a necessary assumption under the supremacy of domestic monetary management in the Keynesian paradigm. Rather, such foreign monetary flows “instead influence the domestic money supply.” Furthermore, the new “‘monetary’ models almost invariably assume…that a country’s price level is pegged to the world price level and must move rigidly in line with this. One justification…is that…competition is so pervasive that elasticities of substitution among the industrial products of the various countries approximate infinity….” And “one further difference” was that “the monetary models assume that output and employment tend to full employment levels….” Johnson provided an equation encapsulating the premise of the new method. This was that “the demand for money may be specified” as

M d  p· f  y·i  .

It was the Cambridge equation, with Md the demand for money, p the price level, y real output, and i the interest rate such that f(y · i) accounted for the apparently passé “homogeneity postulate of monetary theory” attacked by Don Patinkin in the 1950s that the propensity to hold cash balances instead of spending is steady at a given relative price structure, no matter nominal price changes. It was a big summary of Laffer’s recent work in the area. It was a summary of that of others as well, certainly Mundell’s and probably that of Mundell’s former colleagues at the IMF such as Jacques Polak. The article did not contain footnotes. Mundell was the only one of



the Chicago colleagues Johnson mentioned, with Mundell’s “students” cited generically in that fashion. Perhaps since Laffer had been without the Ph.D. at Chicago, he counted in some way as one of Mundell’s students. Foreign flows affect the domestic money supply—this was a standard Laffer  point in his arguments for fixed rates. There is one world price structure owing to efficient markets—another standard Laffer argument, in concert with the work with Fama. Substitution effects support the efficient-­ market one-world price level—redolent of Laffer’s Slutsky-­ equation reasoning. Unregulated economies move toward full employment—with the Cambridge equation centerpieces of “An Anti-Traditional Theory of the Balance of Payments Under Fixed Exchange Rates.” Johnson had noted on the title page of that paper (he and Mundell lingered over titles), “Why not call it ‘A Monetary Theory - - -.’” In February 1971, as Johnson gave his lecture, the 1065 controversy that would rock Laffer’s career had just hit, and the Ph.D. fiasco was weeks away. Over the next several years, the last of Johnson’s life (he would die at the age of fifty-three in 1977), “the monetary approach to the balance of payments” became the crowning achievement of Johnson’s career. Meanwhile, Johnson and Laffer descended into a professional relationship that turned irascible. As Johnson’s biographer Moggridge has noted, Johnson devoted a great deal of attention, in a way unusual for him, to “the monetary approach to the balance of payments.” He may have felt the need to be known by it. Johnson was famous in the profession for the profusion of his work, for writing papers by the hundreds and grading student themes and reviewing submissions quickly and well. He caught a rap for it. He was known as a synthesizer. The quip attributed to George Stigler communicates the matter. In view of Stigler’s having written only 100 to Johnson’s 500 papers, Stigler apparently remarked that indeed, but his were all different. As for the personal bearing of these two Chicago economists, as Samuelson remarked, “there was inside Harry also trace elements of acerbic reprobation: If we put George Stigler at 100 in this department, Harry earned a solid 50.” And “it did not make things better that….fate carried him to the University of Chicago, never known as a particularly harmonious environment.”20 As Moggridge continued, in Johnson’s explorations and advancing of the monetary approach, there was “an aspect of this new development that differed from Harry’s previous work. This time, he seemed to want to



make his own mark and firmly stake his claim to fame.” Furthermore, “he also, much more so than in the past, made repeated attempts to spread the word in various fora with simplified versions of the approach.” The February 1971 lecture reprinted in the scholarly journal the next year actually was not a reprint, Moggridge learned in the archives, but a revision of that lecture and dating from July 1971. It is possible that Johnson took advantage of Laffer’s woes when the Ph.D. debacle hit that spring. Clearly the “Anti-Traditional” paper impressed Johnson. When Laffer failed to publish it and then experienced the ignominy of Stigler’s Ph.D. committee, Johnson may have felt no need to cite his work. Indeed, Johnson may have felt justified in presenting its views without attribution, perhaps as his own synthetic formulation of the monetary-approach movement.21 Johnson and Laffer came to an impasse. In 1974, Johnson tried to ban him from the trade workshop. Laffer hired a law firm to force him back in and cease in any kind of disparagement. Johnson relented, but the unsavory episode was only at the extreme end of the unremitting frosty environment that continued to meet Laffer at Chicago since his return from the Nixon administration. An associate-professor colleague who was particularly scornful of Laffer at this time got a taste of revenge. When this colleague was denied promotion in 1974, Laffer wrote Mundell, telling him that his letter had arrived “in the nick of time.” If Johnson had “lifted” Laffer’s work as he announced the monetary approach to the balance of payments, his readership would have been wise. Laffer’s paper had made a major impression at Chicago. The readership of that paper there, and presumably elsewhere through the economics network, would have easily recognized as such Johnson’s not attributing any ideas to Laffer as Johnson touted the monetary approach in the clear terms of Laffer’s paper. It was a lesson in righteous academic hegemony. If one neglects to finish off publication and then is outed as lacking a degree, people will lift one’s ideas to the approbation of the community. It was part of the shaming process, and Laffer had to take it.22 When Johnson and Jacob Frenkel at last published their major volume of collected works on the topic, The Monetary Approach to the Balance of Payments (1976), Laffer’s signature paper was necessarily referenced throughout the book. In their preface, Frenkel and Johnson wrote that “mention should be made of Chicago Workshop members of the crucial period whose contributions are not included in the volume,” including two graduate students “and Arthur B.  Laffer of the faculty.” Mundell’s



citation, in the volume, of Laffer’s “Anti-Traditional” paper, noted its “including empirical tests,” Alexander Swoboda called the paper still in 1974 “forthcoming,” and Frenkel and Richard Zecher (Laffer’s collaborator at the time) referred to it as an “unpublished manuscript.” The paper remains unpublished.23 Moggridge noted the irony of Johnson’s heavy effort forwarding a new approach to the balance of payments in the period after 1971. “This collapse,” of the international monetary system “into a world of floating exchange rates,” as Moggridge wrote, “meant that the puzzle the approach was intended to explain—balance-of-payments imbalances—ceased to be the centre of concern. Instead analysts were set the task of explaining the behaviour of floating exchange rates, which was something that the approach could in principle do. But it took time to readjust.” It was strange, a big new movement in the 1970s analyzing the favorite international monetary issue of the 1960s that was now a dead letter. Perhaps economists such as Johnson had gotten so used to debating the balance of payments that they could not bear for the issue to depart, even if the departure took place under the auspices of those same economists’ relentless recommendations. Like a bad vacation, the fun is in getting there. Nevertheless, the saliency of the monetary approach in scholarly economic debates through the mid-1970s can signal something more substantial. Perhaps there was a degree of remorse among economists about the events of 1971–73. This may have taken the form, as in Johnson’s pushing of the monetary approach, of a healthy insistence that the intellectual vanguard of resistance from the 1960s, on the currency-cum-balance-of-payments issue, be at last revisited and given the full proper hearing it was denied as the events of 1968–73 came remorselessly in the direction of ever greater floating and flexibility. As for what Johnson himself may have firmly believed, to Robert Bartley he “died a floater.”24 The renewed scholarly interest in a major aspect of Laffer’s work from the late 1960s represented Laffer’s last act as a regular academic. The development was out-of-phase with the priorities Laffer himself was pursuing at the time. The monetary-approach phenomenon came to him; he did not seek it out, much less encourage it as Johnson had. He made his occasional remarks in this vein, such as in his Congressional testimony, but his own economics, and his own career goals, had shifted in other directions. The frostiness at Chicago and his getting rebuffed by the journals, coupled with the excellence of his policy and journalistic contacts, the seriousness of the stagflation problem, and his certainty that his novel and



growing monetary and fiscal model was apt given the challenge, had all but decided for Laffer, by 1976, that he was going to get off the ladder of academic publication and prestige and concentrate, in greater part, on being a policy economist and advocate.

California A marker of the transition Laffer was making came in the form of an extended and widely disseminated publication centering on the work of Mundell and Laffer, including its summaries by Wanniski, composed by Marina von Neumann Whitman. It was part of the annual Brookings Conference on Economic Activity inaugurated in 1969, on economic work relevant to policy choices. The conference took place in December 1975, its papers published shortly thereafter. Her paper was called, “Global Monetarism and the Monetary Approach to the Balance of Payments.” The latter term had already been made current by Johnson. The former, “global monetarism,” was her own coinage. For a while, until the rise of the term “supply-side economics,” it served as the generic descriptor of the school based upon the “Mundell-Laffer hypothesis.” Von Neumann Whitman’s piece, even in its title once again, expressed the two worlds, the one Laffer was migrating from and the other toward. He was leaving behind the world of the scholarly “approach” and entering into that of economic-reform advocacy, captaining a policy movement deserving of a moniker. Von Neumann Whitman captured the ironies, as Moggridge would years later, of the current circumstances. She wrote to begin: A decade or so ago, when the twin concerns about the balance of payments of the United States and the functioning of the international monetary system began to impinge on the consciousness of a public theretofore indifferent to such esoterica, the opinions of those who were already paying attention fell into a neat dichotomy. Government officials and “men of affairs,” on the one hand, insisted that the continued health of international trade, investment, and the world economy required the maintenance of the Bretton Woods system of pegged exchange rates, under which changes in rates were made infrequently and as a last resort. Academic experts, on the other hand, were nearly unanimous in pressing the advantages of greater flexibility of exchange rates, with many urging that governments abstain altogether from intervention and allow exchange rates to be determined by the interplay of supply and demand in the marketplace, just like any other price.



Astonishingly, she might have concluded, it was the “nearly unanimous” academics whose priorities prevailed. And one can make the correction that government officials (and bureaucrats), as Harold James proposed, generally permitted if not encouraged the sense of crisis in the 1960s on the grounds that it made their lives more interesting and their callings more relevant. The silent members of the “men of affairs” cited by von Neumann Whitman were the great class of businesspeople, among whom those in financial circles saw their enterprise models upended with the events of 1971–75, but also primed to take over a massive new share of GDP. “Today,” von Neumann Whitman continued, “most major industrialized countries are no longer bound to pegged exchange rates. But a funny thing happened on the way to this flexible-rate nirvana. The post-Bretton Woods world of managed flexibility has produced surprises undreamed of in the analyses of the 1950s and 1960s.” She was right. One had to call current conditions a “nirvana,” because that is what advocates of flexible rates had all but said their solution would yield. And one had to be ironic in saying so, because global conditions as of late 1975 were those of the dread stagflation. She then introduced her subject, “a small but influential group of international economists [that] has turned traditional balance-­ of-­payments analysis on its head. I have termed this group the ‘global monetarists’—‘monetarists’ because of their [emphasis on] the relationship of the demand for and the supply of money, and ‘global’ because of their conviction that…the world consists…of a single, integrated, closed economy.” She was tracking Mundell and Laffer, and she summarized the nub of the view that they held in common. Their “most startling propositions,” if “put in extreme form…include the following: A change in the exchange rate will not systematically alter the relative prices of domestic and foreign goods and it will have only a transitory effect on the balance of payments.” The substance of Mundell and Laffer’s elective affinities in economics, first manifested in Laffer’s visit with Mundell in Chicago in the spring of 1967, were now set down as their axioms. Von Neumann Whitman named Mundell and Laffer as the primary exponents of the global-monetarist viewpoint, offering Wanniski’s “Mundell-Laffer Hypothesis” as a useful introduction. She cited Mundell’s standard works and Laffer’s chapter in The Economics of Common Currencies, but not a Chicagoan, she did not cite “An Anti-Traditional Theory.” Her long essay detailed as fully as anything to date the currency perspective Mundell and Laffer had brought to the distemper of the 1970s. She was generally supportive, offering criticisms mainly along the



lines of noting that their assumptions (such as of efficient markets) were too pat. Yet just as Laffer was preparing his winding-down of scholarly in favor of policy economics, it was von Neumann Whitman’s judgment that “as of most challenges to orthodoxy, a winnowing process is now underway,” and “the insights of the monetary approach to the balance of payments analysis [are] rapidly being co-opted into the conventional wisdom itself.” Laffer’s shaming since the Ph.D. flap had perhaps run its course. Scholarly economics was laying out a future for him again as a leader of an important new school, if one, as Walter Salant said in comments on the paper had Mundell and Laffer in its number “and, so far as I know, few if any others.” The month after the Brookings conference, in January 1976, Laffer met Rep. Jack Kemp of New York. He was introduced to him by Wanniski, who had sought Kemp out on Bartley’s suggestion. The three quickly became a trio, Kemp, Wanniski, and Laffer. Kemp had written up several bills that attempted to get at the stagflation conundrum. The main focus of these bills was more production, given the premise that more goods solve the growth and inflation problem simultaneously. Over apparently very intense meetings—this was during the thick of the Michael 1 dinners as well—Laffer, traveling to Washington or speaking on the phone multiple times daily, would with Wanniski pore over with Kemp the foundations of the Mundell-Laffer hypothesis. Kemp’s bills emphasizing the likes of an investment tax credit did not impress Laffer and Wanniski as getting to the heart of the matter, the wedge and presumably the Laffer curve. An investment tax credit—a credit not a marginal cut—could possibly and indirectly effect the wedge of one party, the supplier. A tax-rate cut, however, reduced the wedge as its primary accomplishment. In 1977, Kemp reintroduced his bill as an across-the-board tax-rate cut of 30 percent after the fashion of John F. Kennedy’s tax cut of 1963. The top income-tax rate at this time was 70 percent, the lowest 14. Two months after Laffer met Kemp, and three after von Neumann Whitman’s Brookings paper, Herbert Stein, the former Nixon CEA member and chair, in March 1976, gave a talk at the Homestead resort in Virginia in which he referred to the “supply-side fiscalists,” a group which numbered “maybe two.” Stein was a member of the Wall Street Journal Board of Contributors, and Wanniski found out about the remark from an associate of his who was there, Alan Reynolds. Wanniski liked the sound of the quip and changed one term, coining “supply-side economics.” Laffer approved of Wanniski’s rendition and took on the label. At some point in



1977, it supplanted “global monetarism” as the descriptor of the economic-­ reform philosophy Laffer, along with Mundell, Wanniski, Bartley, Kemp, and a growing number were espousing. As of that spring, it had not quite yet. As Laffer wrote Mundell in May, “I really believe Global Monetarism and the ‘Wedge’ are really catching on.”25 The California industrialist Justin Dart, who since the 1940s had alternatively led both the Walgreen’s and Rexall drug-store corporations, first met Laffer briefly at an event while Laffer was a business student at Stanford in the 1960s. The acquaintance was renewed care of Dart’s daughter Jane, or “Winkie,” while Laffer was at OMB. Winkie and her husband John Campbell worked in Ehrlichman’s office. Dart was very interested in the economics Laffer propounded to him as stagflation came on in the 1970s. Moreover, he was part of a circle of the California elite that met and socialized with the Republican governor (through January 1975), Ronald Reagan. Meanwhile, the Texas Tech business school dean, Jack Steele, who had courted Laffer in 1972 was now dean at the business school at the University of Southern California, in Los Angeles. In conversation with a prospective donor, Charles “Tex” Thornton, founder of Litton Industries, Steele arranged for Laffer to be the inaugural occupant of the Thornton Professorship of Business if Thornton would endow it. Laffer confirmed that he would accept, and Thornton funded the chair. Laffer left the University of Chicago after the spring of 1976 for his new tenured appointment at USC. As Thornton professor, he also ran the Dart center for entrepreneurship. In December 1975, while still at Chicago, Laffer spent his first extended time with Reagan. In Los Angeles, they had lunch with several others and discussed policy. It was, as Reagan confirmed in his letter of appreciation to Laffer several weeks later, “the first meeting of a planned series of meetings that I hope to have with leading experts on a variety of key issues that are of critical importance to the problems that our government must cope with today. I hope that succeeding meetings will be as lively and productive as this one.” They had met, as Reagan noted, about “the basic economic issues facing our country.” Martin Anderson, a former colleague from the Nixon administration and a top Reagan advisor, had arranged the date and brought Laffer into the group.26 When Laffer moved to Los Angeles that summer, he quickly became part of Reagan’s social circle. He fitted in with Ronald Reagan and his wife Nancy’s “kitchen cabinet” of wealthy couples who regularly gathered together, often at the Reagan home in Pacific Palisades, for soirees. Justin



Dart and his wife “Punky,” the former Warner Brothers actress Jane Bryan, were core members of the group. As Bob Colacello recounts in Ronnie & Nancy, “the close connection between the Reagan’s social and political lives during this period is perhaps best illustrated by Justin Dart’s promotion of Arthur Laffer….It was at that [December 1975] meeting, Anderson recalled, that Reagan probably first heard the supply-side gospel as preached by the thirty-five-year-old Laffer: ‘If you cut tax rates, revenues may go up. It you raise tax rates too much, income goes down.’” Colacello noted that “a month after Laffer arrived in Los Angeles, in September 1976, Reagan wrote a column called, ‘Tax Cuts and Increased Revenue.’ He cited the tax cuts of Presidents Warren Harding and John F. Kennedy and wrote, ‘Since the idea worked under both Democratic and Republican administrations before, who’s to say it couldn’t work again?’”27 Laffer settled in Palos Verdes Estates southwest of Los Angeles, as his parents would shortly as well in Rancho Santa Fe, his father becoming close there to Neil Reagan. The gatherings became frequent of “the Group,” as the members called themselves under Ronnie and Nancy’s aegis, the Punky and Justin Darts, the Marion and Earle Jorgensens (their fortune was from steel), the Grace and Henry Salvatoris (oil), the Bunny and Jack Wrathers (oil; Bunny like Punky a former actress), the Virginia and Holmes Tuttles (auto sales), among others including the Annenbergs, the Guggenheims, and the Ardie Deutsches. It was a marked difference, as a scene, from the unsavory book-smart environment which had turned off Laffer’s society mother when she visited her son’s office and saw the colleagues at Chicago in the late 1960s. The pettiness at that institution, after the Ph.D. flap, included such things as removing Laffer’s access to the typing pool and long-distance calling. On leaving Chicago in mid-1976, Laffer switched an unwelcoming intellectual environment for a new situation not only high class but one squarely in the arena of policy as well. Right away a group of private farmers hired him to do television ads against a ballot initiative of Cesar Chavez’s United Farmworkers to expand its prerogatives, including allowing outside union-organizing on farm property, a measure that failed at the polls by a 2-1 margin.28 As Colacello found about the Reagans during the years of “Ronnie’s” governorship, “the couple who had once been thought of as hopelessly B-list were now the highest-ranking personages in the state, and the social stock of their friends and backers in Beverly Hills and Bel Air was soaring.” During those eight years, “the Group” built up a momentum of camaraderie and (given all the entrepreneurs) determination to score further



accomplishment. The esprit de corps of the Group was crucial in bearing Reagan along toward his decision to run for president first in 1976 and then in 1980. In a remarkable turn of events for an academic economist, “Laffer was a regular guest at Punky and Justin Dart’s dinner parties, where ‘he was always going on about cutting taxes,’” as another attendee told Colacello. As for Dart, Laffer told Colacello that he was “not afraid to overstep himself. His basic political principles were pro-growth, pro-­ business, supply-side intuitively. He was not Holmes Tuttle”—one of Reagan’s earliest political advocates in the early 1960s—“who said balance the budget, don’t cut taxes. For a crusty old curmudgeon, Justin Dart just got it.” Laffer conceivably could have flopped in this environment. As Colacello notes, “Laffer’s heterodox views and brash personality made him a contentious figure within the Reagan’s inner circle. One who was not so sure about him was Nancy herself. He, in turn, found her impressive but intimidating.” Once in an evening with the Group at the Laffer home, Laffer’s young daughter Rachel showed Mrs. Reagan her pet ferret, and Nancy made it clear in no uncertain terms that she was not to be in the presence of such things. It is clear that once Nancy saw how much her husband attended to Laffer’s economics and the plan it implied, given the ever-­ persisting stagflation through the late 1970s, she marked Laffer as an essential member of the Group.29 Laffer’s move to California in 1976 cast his academic career in economics, dating from his enrollment in the Stanford program in 1965 to that point, as an interregnum from the major course of his life, from the sociological context that had held when he was growing up and then would hold again after his time in the intellectual hothouse of a top university faculty. He and his society mother and Fortune 500 chief-executive father, both parents themselves who had grown up in the milieu of the high season of American privilege, in the Cleveland resplendent in the wealth brought by the supreme business of American history, that of Rockefeller, were “a team” in the 1940s and 1950s, as they told themselves. The threesome had a similar outlook and vision. They were to do successful things in the tradition of their forbearers, and in the process associate with others of a similar disposition. The course of Arthur Laffer’s preparation through school and Yale College and Stanford Business School, with the offers from Morgan Stanley and others on gaining the MBA, was consistent with the sociological framework of the Laffer household and the expectations put on the youngest and most affable son.



The pursuit of the Ph.D. and the immersion in the Chicago faculty were diversions into a sub-world at an order of remove from that of ancestral pedigree and corporate success. That sub-world represented, to some degree, an alternative and perhaps a rising establishment whose symbols of prestige—professorships, publications—could challenge the supremacy of those of the business elite. It was comparatively déclassé in its manners and in the origins of its members, but that it had broad ambitions was just as clear. Its members bid to command the attention, respect, and support of the business and political elite, perhaps to the extent of expecting acquiescence to their economic worldviews and policy recommendations. Laffer was an emissary into that world from the traditional American establishment. For the first few years, it appeared that he was supremely functional as an academic economist. The process of his alienation that began with the Nixon hitch functioned, whatever the particularities of the experience, to return Laffer to the conditions of his status quo ante. He had been the son of successful Clevelanders at the top schools and with intriguing prospects, and once in California after 1976 his associations would be with the power socio-business elite and his influence within it direct. As he went through this reversion, he brought with him as useful materials the insight and perspective he had honed as a member of the alternative establishment of scholarly economics. In 1964, E. Digby Baltzell published his classic study of The Protestant Establishment. One of Baltzell’s progressive conclusions was that the ethnic and religious markers of candidacy in that establishment should at last be dispensed with, not only in the name of justice but efficiency as well. Persons of non-white races and non-Protestant religions should substantially repopulate the American elite over the next generation, Baltzell felt, if the nation was to continue with its success in breeding wealth and that unique development in world history, a mass middle class. In 1971, a book spawned from deep within the unanalyzed subconscious of the Protestant establishment—Baltzell’s book was plainly conscious of itself— shook intellectual life. John Rawls’s Theory of Justice contended that privileges of any sort in society must not have any influence whatsoever on the formation of civic norms and rules. Just when the Protestant establishment was certain that it was definitively in its period of waning, as Baltzell’s book had confirmed, Rawls came in and said that the whole idea of building upon privilege was a false one. If Protestants were not going to have their privilege, no one was. Bartley, for his part, found A Theory of Justice infuriating.30



To talented, ambitious young people from that waning establishment— one can think as well of William H. Gates III in the 1970s in this context—it was not apparent that they should regard their privilege as anything other than a non-transferable productive capital asset. In his Humphrey-­ Hawkins testimony, Laffer referred to the unemployed as a “perishable resource,” indicating that it was folly not to engage it as such. Laffer was prepped and educated and experienced in all the right diversions and turned out to be a natural at international macroeconomics. The sum of the parts was inseparable. He was successful in good part because he came from success and his family had marked him out for such a fate. However, a flat-note tug of his original world continually made itself felt. In using the term “Anti-Traditional,” Laffer was referring not to “traditional” elements of tradition such as social class, but the nouveau intellectualist traditions of Keynesianism and monetarism. Furthermore, his disregard for getting the doctoral degree was awfully consistent with haute bourgeois disdain for those lowborn strivers for whom credentials were a pure necessity. None of this is to mention stagflation, the rather absurd backdrop to Laffer’s alienation from the academy and rush right into the bosom of a reform-demanding power elite. Stagflation remained the necessary condition. It conferred to Laffer a relevance and urgency which he would not have had otherwise. In the first place, it discredited the rising status challenger, academic economics. Marina von Neumann Whitman made an obvious point when she noted that one group above all had encouraged flexible exchange rates and provided assurances of their absolute benignity. Stagflation trashed the reputation, among secular American society, of this set of economists, as Lucas and Sargent soon would fully acknowledge. Yet those economists, as Laffer and Mundell exemplified, who had remained steadfast in their opposition to the flexibility consensus and the cashiering of gold acquired a credibility that went beyond that which they had first garnered professionally in their scholarly work. Stagflation moreover created a policy urgency. Something had to be done about it, lest the nation lose its fortunes, confidence, and democratic appeal. Laffer touted answers. That stagflation had not sullied but vindicated his economics made the likes of Nancy Reagan set aside any concerns and offer him a prime place from which he could strive to elicit reform.



Notes 1. Jude Wanniski, “It’s Time to Cut Taxes,” June 13, 1997,; “It’s Time to Cut Taxes,” WSJ, Dec. 11, 1974. 2. Kudlow and Domitrovic, JFK and the Reagan Revolution, 161. 3. Domitrovic, Econoclasts, 103. 4. Rick Perlstein, Reaganland: America’s Right Turn 1976–1980 (New York: Simon & Schuster, 2020), 283. 5. Mundell, “The Dollar and the Policy Mix,” 11; the quotations in the following paragraphs are from Wanniski, “The Mundell-Laffer Hypothesis.” 6. Arthur. B. Laffer, “An Economic Reform Program,” Nov. 1, 1974, folder “An Economic Reform Program, 11/1/1974,” Laffer archive. 7. Arthur B. Laffer, “The Reinstatement of the Dollar: The Blueprint” (Feb. 29, 1980), in The Pillars of Reaganomics: A Generation of Wisdom from Arthur Laffer and the Supply-Side Revolutionaries, ed. Brian Domitrovic (San Francisco: Pacific Research Institute, 2016), 24–39. 8. Bartley, The Seven Fat Years, 49; Keynes, “Preface to the French Edition” (1939), The General Theory of Employment, Interest and Money. 9. Peter F. Drucker, “The Five Deadly Business Sins,” WSJ, Oct. 21, 1993. 10. Tobin, The New Economics One Decade Older, 4, 72, 100. 11. George J.  Stigler to Louis Henkin and Stephen Marcus, Dec. 8, 1978, “Economics in the Rear-View Mirror,” 12. Mehrling, Fischer Black and the Revolutionary Idea of Finance, 157–63. 13. Full Employment and Balanced Growth Act: Hearings before the Subcommittee on Employment, Poverty, and Migratory Labor of the Senate Committee on Labor and Public Welfare, May 14, 17–19, 1976, pp. 166–85. 14. Baran and Sweezy, Monopoly Capital, 382. 15. Baran and Sweezy, Monopoly Capital, 45–46. 16. Arthur B.  Laffer, “Exchange Rates, the Terms of Trade, and the Trade Balance,” unpublished paper, June 1974; “Stylized Fallacies of International Trade,” n.d. (circa 1971), Laffer archive. 17. Borts to Laffer, March 19, 1974 and Feb. 26 and May 11, 1976, Borts file, Laffer archive. 18. Marina v.N. Whitman, “Global Monetarism and the Monetary Approach to the Balance of Payments,” Brookings Papers on Economic Activity 3 (1975), 491–555. See this source for the quotations in the following pages. 19. Harry G.  Johnson, “The Monetary Approach to Balance-of-Payments Theory,” Journal of Financial and Quantitative Analysis 7, no. 2 (March 1972), 1555–72. 20. Paul A. Samuelson, “Samuelson on Harry, the Full Achiever,” in “Harry G. Johnson: Scholar, Mentor, Editor, and Relentless World Traveler,” 605. 21. Moggridge, Harry Johnson, 348.



22. Laffer to Mundell, June 12, 1974, Personal file, Laffer archive. 23. Jacob A. Frenkel and Harry G. Johnson, eds., The Monetary Approach to the Balance of Payments (New York: Routledge, 2013), 10, 92n, 146, 247, 297. 24. Moggridge, Harry Johnson, 352; Bartley, The Seven Fat Years, 48. 25. Bartley, The Seven Fat Years, 44; Laffer to Mundell, May 28, 1977, Laffer archive. 26. Reagan to Laffer, Jan. 12, 1976, Laffer archive (letter now in possession of the Young America’s Foundation). 27. Bob Colacello, Ronnie & Nancy: Their Path to the White House—1911 to 1980 (New York: Warner Books, 2004), 470–71. 28. On the initiative, see Matt Garcia, From the Jaws of Victory: The Triumph and Tragedy of Cesar Chavez and the Farm Worker Movement (Berkeley: University of California Press, 2012), 164–77. 29. Colacello, Ronnie & Nancy, 375, 471. 30. Historiography in search of Rawls has begun with Katrina Forrester, In the Shadow of Justice: Postwar Liberalism and the Remaking of Political Philosophy (Princeton: Princeton University Press, 2019) and Eric Nelson, The Theology of Liberalism: Political Philosophy and the Justice of God (Cambridge, Mass.: Harvard University Press, 2019).


The Arc of Reform

As he introduced his economic mentors in The Seven Fat Years, Bartley wrote of Laffer and Mundell (and his own understudy Wanniski), that beside their “luxurious plumage, … the rest of us” at Michael 1 “were drab.” Even Charlie Parker, who had first corralled Laffer into the world of investment research and clients when Judy Thornber had a nose for her business professor, Bartley put in the latter category. That man-about-­ town, Bartley said, was drab compared to Laffer and Mundell. Bartley, with his squared-off glasses and soft hair on his head, let the stillness of his waters run deep in his writing, his editorials. His express pride was to confer “muzzle velocity” to them.1 The luxuriousness of the plumage of Laffer and Mundell was different in each case, complementary. Laffer was fast-talking, Mundell a mumbler. Laffer had grown up in the Fortune 500 set, Mundell among those who worked cheese farms. Mundell had blown economics away with theory and algebra in the journals in the late 1950s and early 1960s—as even Stigler was pleased to say—and Laffer, eight years junior, via argument and statistics in his papers had won early tenure at the most legendary place in the discipline’s history before he was thirty. Yet only when it came to their ideas fitting together like a puzzle, as things settled in at Michael 1, did those ideas begin to find serious traction in practical affairs. In bringing the overly theoretical, scholarly, and quirky-like-a-professor Mundell into the Wanniski-Bartley ambit, Laffer gave the economics of © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 B. Domitrovic, The Emergence of Arthur Laffer, Archival Insights into the Evolution of Economics,




this theorist the rare chance to have practical effect. And in seeing to it that Mundell had the attention of Wanniski and Bartley, Laffer ensured that his own ideas, through Mundell’s endorsement of them, gained a greater degree of validation before his outside-world audience. It was a canny move on Laffer’s part. Mundell had no chance—given his abstraction and oddities—of being effective in the hurly-burly of practical political economy on his own. Laffer took advantage of being at home in the two worlds, of academics and real affairs, to see that the “Mundell-Laffer hypothesis” vaulted, in a few years’ time, to the center of American political-­economic consideration, as the nation became attentive because of persisting stagflation. The  early emphasis Laffer placed  not on economics but engineering perhaps reflected a penchant for practical problem-solving, one he brought to his economics. His father ran Clevite, he had studied at the Yale School of Engineering (if with some difficulty), and he had bonded with William Shockley. He was also by rights cultured, raised among the Airedale kennel, the George Szell Cleveland Orchestra, prep schools, the Ivy League, and Stanford. Mundell went to a land-grant university for his Ph.D., even if it was MIT, and was publicly educated otherwise. He too was supremely cultural, developing sensibilities, and weaving them into his economics to an absent-minded fault. The difference between Laffer and Mundell on this score was on display at the world inflation conference of May 1974. With disorientation set in over the huge price increases, and the economists all gathered to nail down what was going on, Laffer offered arguments and numbers. He had his student Moon Hoe Lee’s statistics on the exact correspondence between a country’s currency devaluation against major trading partners and the degree of general price appreciation in that country. Mundell in the thick of this inflation maelstrom: The great inflation of the middle fourteenth century was probably caused by the excess supply of money arising from the Black Death (1348–1350), which followed on the heels of the great banking crisis of the 1340s. In 1355 the legal monopoly of gold coinage by the Holy Roman Emperor, long since usurped by the kings of Europe, was formally abandoned, and the connecting thread of the eight-centuries-old Byzantine unit of account crumbled into the bimetallic chaos of the later Middle Ages. During this period John the Good of France devalued eighty-eight times.



Laffer and Mundell were a team, to be sure. The one socially fitted, argumentative, and practical, the other ethereal and imaginative but with the ability to be dead-on. Laffer’s bringing Mundell into the Wanniski-Bartley circle addressed the potential status anxiety that might come as Laffer increasingly forwarded his economics in the realm of practical affairs. The more practical Laffer became, the more it might appear to his audiences that he was alienated from pure theoretical economics. With Mundell verifying Laffer’s notions in his own idiom, Laffer’s ideas appeared not only as practical, but consistent with a scholarly vanguard.2 One further reason that it is unlikely that Laffer drew his curve on a napkin for the first time is that the Laffer curve was the first curve in the Laffer oeuvre. As of 1974, Laffer’s work did not have curves. It had prose, contentions, equations, and statistics. If there was a plot, it came from given data, not algebra, after the fashion of Baran and Sweezy in Monopoly Capital. In his study in 1973 or 1974, working out his single-factor-­ production model’s differential equations that would culminate in a curve, Laffer was channeling his friend Mundell, whose math-based graphs were the centerpieces of his esteemed articles. It was perhaps somewhat out-of-place that the movement that Laffer, with the assistance of Mundell’s wisdom, seeded, the supply-side-­economics revolution, centered on taxation. The economics of these two professors had developed as an economics of the monetary regime. They had their fiscal and taxation sides, to be sure, Mundell more than Laffer explicitly, as in the transfer-problem taxes. Laffer was, however, closer to the economics of taxation in the first years of his career than his papers might have let on. His emphasis on the endogeneity of money implied that there was a dynamic inherent in an economy, especially one that was growing, pushing the money supply to its extent. For Keynes this was “animal spirits,” attenuated as they became after the advance of the industrial revolution created a block of inherited rich lacking the will to invest as opposed to living on the nice interest. It took Laffer a period of time to figure out what his missing element was. But as he tried his hand at doing modeling equations that could be expressed as graphs, he came up with his answer. The marginal tax rate was the delimitation of the propensity to grow. Laffer is a subject of interest today, to be all too reductionist about it, because of the great turn that came with the first years of the Reagan administration, which this renegade economist according to good evidence like Bartley’s played a central role in seeding. In the 1980s through the 1990s, the United States traded losing for winning on normal criteria,



having done quite the opposite in the 1970s over the 1960s and 1950s. The 4-percent growth runs of 1982–1989 and 1994–2000, with inflation at 3 percent instead of the customary even triple that in the stagflation period dogged by double-dip recessions, force attention onto the likes of Michael 1 in the mid-1970s, as the stock market seems to have perceived. Even the whole Chicago School—arguably economics itself—cheated the hangman because of the Reagan turn. Stigler needed the 12 percent real noninflationary growth of 1983–1984 as the propitious context for his article on “Economics—The Imperial Science?” Absent that development, if stagflation had persisted and worsened through the 1980s if that can be imagined, it is not unreasonable to suppose that trustees at an institution like Chicago would have questioned continuing to devote resources to a failing field. Absent the strong noninflationary growth of the 1980s and 1990s, macroeconomics as a whole would have had trouble getting out of the morass laid out by Lucas and Sargent in 1979. Events would have discredited it ever more deeply. The popular and financial pressure for macroeconomics to attenuate or expire would have been severe, more severe than it was in 1980, when the profession was getting desperate. Laffer and Mundell, those cranks, did their part to save the discipline that had snubbed them. The Yom Kippur War and the oil shock of 1973 is another distractor, a stratagem that the collective consciousness of establishmentarian economics lets persist as a prime suspect for the cause of stagflation. The simple matter of correlation is that against the lack of interest on the part of the mass of participants throwing themselves into postwar prosperity, the major macro schools collectively dropped their differences (Keynesianism, monetarism) so as to make a unified push to bring down all remaining elements of a classical monetary system, from gold to fixed rates to multiple competitive currency issuers at par. The results, of the 1970s, proved the effort a manifest failure, surely one of the worst in the history of the academic-­policy nexus. The decisiveness of the Reagan turn after 1982 has permitted economics not to own up to its mistake, but rather to try to be first among the thousand fathers laying claim to the success. The 1980s and 1990s—they came care of academic theory, rational expectations surely, and hardheaded Paul Volcker at the Federal Reserve. Yet if Fischer Black was right at all, Volcker was irrelevant to history. The superciliousness toward gold in particular in the high economics set remains suspicious as a social-psychological marker. All the top economists, even those at Chicago, dismiss gold outright as hopelessly



unworkable, outmoded, constricting, benighted, and the cause of the Great Depression itself. Not only journal articles show this, but polls of the top economists too. Yet how did it go after gold was dropped on the pan-professional advice of economics? Von Neumann Whitman reminded everyone as stagflation raged in 1975 that what was supposed to be obtaining then was “nirvana.” Wanniski’s napkin with Laffer’s scrawl saved flexible exchange rates, made the world safe for high-hatting gold from academic chairs. The American tax-rate cuts of 1978–1986, of which the Laffer-curve-on-anapkin was the unmistakable emblem, taking the capital-gains rate down by an average of half (more in real terms), the marginal income rate first to 50 from 70 percent and then after a 97–3 vote in the Senate in 1986 to 28 percent, and the corporate rate, and so on, down as well too, corresponded to a large, serious, and sustained boom in economic output and return on investments. In the 1990s, the opposition settled on conceding Reagan more than half of his victories. Clinton’s 39.6 percent marginal income-tax rate split the difference between the two Reagan rates, and Clinton took the capital-gains rate to the lowest Reagan rate (20 percent) and kept the corporate rate (35 percent) a point above Reagan’s lowest. Laffer noted that his curve has its final effects as tax-rate cuts settle in, changing behavior across all time horizons. The great growth of the 1980s and 1990s at the hands of supply-side policy saved the flexible-rate experiment of the 1970s. This development was not perhaps as ironic as it might appear. In the first place, flexible rates did confer greater maneuverability in domestic policy. Countries could pursue monetary, tax, spending, trade, and regulatory policies without immediate concern for an exchange-rate par. This meant that the range of variation among domestic policies of the nations of the world stood to be greater under flexible as opposed to fixed rates. Those countries concentrating, in the new environment, on increasing the real rate of enterprise return, through tax-rate cuts for example, would claim an excess share of world capital because other places had more discretion not to pursue such goals—or to pursue goals much the opposite. The capital moves to the growing places, per the Sidney Alexander absorption process, would be all the more massive. To accommodate such moves, the growing places would have to see substantial deteriorations in their trade balances—as happened in the central example, the United States in the 1980s.



As Laffer wrote of the British and Irish experiences from the latter 1980s through the early 2000s, if a country is singular in cutting tax rates, it will endure inflation only if it fails to permit its currency to appreciate. In attracting capital, a country bids up prices of its tradeable goods, its imports and exports, compelling the relative price structure to follow suit in a general inflation. To forestall this inflation, the currency must be, as Laffer said of the Irish punt fixed to the euro in 2000, “free to move.” Arguably, a similar process was afoot under fixed rates in the 1960s. The Kennedy tax-rate cuts, along with allied policies liberalizing trade and investment taxation, correlated to a doubling of the inflation rate, if from the low rate of about 1.7 percent to some 4 percent from the early to the latter 1960s (and as the dollar appreciated against such major currencies as the pound sterling). Even so, however, the general fixity of global exchange rates at that time ensured that any nation within the system could not pursue a domestic policy at tremendous variance from the norm. The American inflation that developed was a comparatively moderate one, until the abrogation of gold in 1971 and the deliberate devaluations of the dollar.3 Moreover, flexible rates in the contemporary period are not a comprehensive norm. The current aspirant to global hegemony, China, is the prime illustration. China chose not at all to follow the regime of flexible exchange rates as it made its decades-long bid for ascendancy. It set aside qualms and made its model Hong Kong, by the 1980s about the richest place on earth, having been nothing to speak of in 1945, as Friedman pointed out on television. After the 1970s distemper, Hong Kong not only settled on a fixed exchange rate, to the American dollar, but to having a “currency board,” under which it issued no currency unless presented with a fixed amount of foreign exchange, namely the dollar, as a trade. Therefore Hong Kong, in the greater part of the post-1971 epoch, tightly displayed at least three of Laffer’s monetary principles. It had a fixed exchange rate. It outsourced its monetary policy to the rest of the world. And its money supply was inescapably endogenously determined—the only time the board created currency is when someone wanted to buy it. Result: circa richest place on earth and inspiration for the world-historical switch of the People’s Republic toward a market economy.4 China itself stopped short of the currency board. Pride did not permit baldly outsourcing monetary policy to holders of the dollar. But exchange-­ rate fixity, maintained via huge dollar reserves used to peg the country’s currency against the dollar on the international exchanges, is a hallmark of



China’s enormous economic rise over the last decades. The pegging procedures are not terribly different from those that prevailed under Bretton Woods. Follow the money. When places want to get very serious, economically, after 1971, they may flatter the flexible-exchange-rate system in words, in academic articles and the like. But they fix their exchange rates to the (post-stagflation) dollar  as under Bretton Woods, if not drop all pretense about central banking and concede that the money supply is endogenous by having a currency board. In his march into economics from the Stanford years on, beginning with his tutelage under Despres, Laffer made it his purpose to help the discipline resist its urge to take away that foundation of the mass-affluent society, the remaining features of a classical monetary system including gold and fixed rates. On failing to stem the tide of that development, he hit on the idea of the tax wedge care of which, as Lucas said in 1990, supply-side economics “delivered the largest genuinely free lunch I have seen in 25 years in this business.” As Laffer settled into the Reagan circle in 1976, the restoration of conditions akin to postwar prosperity, no matter the disorienting severity of stagflation, stood as the goal to be achieved.

Notes 1. Bartley, The Seven Fat Years, 44; “Bartley, Longtime Journal Editor and Thinker on the Right, Dies at 66,” WSJ, Dec. 11, 2003. 2. The Phenomenon of Worldwide Inflation, 141–42. 3. Arthur B.  Laffer, A Template for Understanding the Economy (Nashville: Laffer Associates, 2019), 71. 4. See Brian Domitrovic, “The Emerging International Currency Crisis: Currency Boards Can Stave It Off,” Laffer Associates, Nov. 8, 2018.

A Note on Sources

Extensive oral history of Arthur B. Laffer is the source of the great part of the uncredited information about this economist’s life and career in the text. I conducted oral history, at first formally, and then far more extensively and informally, over the thirteen years from 2007–2020, during which time I became both a close friend of the subject’s and a contract worker and employee of the Laffer Center and its predecessors. I am the Richard S.  Strong Scholar at the Laffer Center. This oral history is not attributed in the notes. Nor for the most part are matters of fact of general establishment, confining the notes, largely, to the attribution of quotations. Statistics are from the conventional sources, such as the Federal Reserve Economic Data (FRED) and Federal Reserve Archival System for Economic Research (FRASER) databases of the Federal Reserve, the Bureaus of Economic Analysis and Labor Statistics, Statistical Abstracts of the United States, the Census Bureau’s Business Conditions Digest (these two cited in the notes),, National Bureau of Economic Research (NBER) databases, the “DMDC” for military-­ personnel levels, and corporate-profit digests in the Wall Street Journal (WSJ ). Presidential oratory is generally uncited, discoverable through a date search in the Public Papers of the Presidents. The Laffer archive is a private collection of the subject’s in Nashville, Tennessee.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 B. Domitrovic, The Emergence of Arthur Laffer, Archival Insights into the Evolution of Economics,



A Abramovitz, Moses, 31, 32 Airedale terriers, 156 Alexander, Sidney, 35, 243 American Dream, 3 American Economic Review (AER), 4, 5, 8, 33, 34, 36, 39, 45, 51, 54, 57, 62, 65, 66, 68, 70, 73–75, 82, 86, 93, 135–137, 159, 189, 217, 223, 224 American Enterprise Institute (AEI), 181, 182, 199, 224 Andersen, Leonall C., 97 Anderson, Martin, 232, 233 “An Anti-Traditional Theory of the Balance of Payments Under Fixed Exchange Rates” (Laffer), 14n6, 54, 58, 64n16, 72, 73, 137, 226 Aristotelianism, 150, 152 Arnett, Grace-Marie, 191, 205 Arrow, Kenneth, 32

B Balance of payments, 6, 7, 12, 14n6, 15n9, 23, 39, 41–62, 67, 70, 77, 142, 147, 155, 156, 166, 170, 175, 176, 178, 179, 223, 224, 226–231 Baltimore Orioles, 121 Baltzell, E. Digby, 235 Bank of International Settlements, 69, 140 Baran, Paul A., 17–39, 150, 220, 221 Bartlett, Bruce, 15n9, 192, 202n13 Bartley, Robert L., 11, 128, 144n12, 160, 161, 166, 176, 177, 181, 182, 191–201, 209, 210, 216, 228, 231, 232, 235, 239–241, 245n1 Base vs. superstructure, 151, 153 Bell, Alexander Graham, 154 Belle Époque, 215

 Note: Page numbers followed by ‘n’ refer to notes.


© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 B. Domitrovic, The Emergence of Arthur Laffer, Archival Insights into the Evolution of Economics,




Benign neglect, 7, 14n5, 50 Bernanke, Ben S., 66 Betz, Arthur B., 20 Bitcoin, 83 Black Death, 240 Black, Fischer, 107, 157–160, 166, 167, 180, 210, 218, 219, 242 Blough, Roger, 99 Bober, Stanley, 65–67, 69 Booth, David, 159 Borts, George H., 57, 73, 224, 237n17 Bourdieu, Pierre, 152, 172n4 Bretton Woods, 6, 22, 23, 35–38, 43, 48–50, 61, 67, 72, 75–79, 83, 94, 141, 148, 163, 175, 176, 178, 182, 198, 214, 215, 229, 245 Brookings Institution, 42, 46 Brunner, Karl, 106, 112n17, 177 Buckley, William F., 32 Budget, United States, 115 Bureau of the Budget (BoB), 93, 100 Burns, Arthur F., 104, 112n14 C Cambodian spring, 101 Cambridge equation, 59, 225, 226 Carlson, Keith M., 97, 112n5 Carson, Johnny, 154, 165 Carville, James, 208 Cheney, Richard, 11, 183, 191, 205, 206, 211, 219 China, 43, 47, 94, 140, 244, 245 Cleaveland, Moses, 21 Cleveland, 3, 18, 20–22, 33, 39, 44, 138, 156, 234 Clevite (Cleveland Graphite Bronze Co.), 18–21, 30, 32, 40n2, 240 Clinton, Bill, 196, 243 Coase, Ronald, 44

Colacello, Bob, 153, 233, 234 Connally, John, 156, 173n16 Consumer Price Index (CPI), 140, 141, 175, 200 Council of Economic Advisers (CEA), 22, 98–104, 108, 115–118, 120–130, 139, 142, 178, 217, 231 Cranks, 13, 47, 83, 151, 153, 154, 164, 196, 208, 218, 242 Crowding-out, 193, 200, 201 Currency board, 197, 244, 245 Cuyahoga County (Ohio), 21 D Dart, Jane and Justin, 232–234 Davidson, Sidney, 134, 136 De Gaulle, Charles, 78, 148, 178 Deadweight loss, 27, 169, 190 Denison, Edward F., 53, 57, 61 Despres, Emile, 32, 39, 45, 46, 48, 50–52, 57, 63n6, 66, 74, 76, 78, 79, 82, 132, 137, 139, 179, 197, 245 Deutsch, Ardie, 233 Devaluation, 9, 28, 33, 34, 48, 55, 62, 76–78, 86, 155, 161, 166, 167, 169, 177, 179, 180, 182, 198–200, 212–214, 218, 223, 240, 244 Dillon, C. Douglas, 69 Dollar, 4, 6, 9, 17, 22, 23, 32, 34, 46–54, 66, 67, 69, 71, 75–81, 83, 86, 87, 94, 97, 101, 128, 140–143, 149, 155, 161, 162, 164, 167, 169, 170, 175, 176, 179, 180, 198–200, 206, 207, 211–215, 244, 245 Dollar glut, 46, 67 Dornbusch, Rudiger, 43, 63n3, 63n4, 71, 72


E Eckstein, Otto, 97 Economic Report of the President, 101–103, 108, 115, 117, 125, 126 Economics (Samuelson), 54, 121 The Economist, 50, 76, 79 Efficient markets theory, 93, 94, 96, 219 Ehrlichman, John, 94, 104, 232 Eisenhower, Dwight D., 19 Emmett, Ross B., 71 Employment Act of 1946, 116, 129 Endogenous character of the money supply, 96, 105, 118, 244, 245 Engerman, Stanley, 23 Erhard, Ludwig, 148 Ex ante vs. ex post, 122 F Fairchild Semiconductor, 19 Fama, Eugene F., 44, 93, 94, 135, 159, 224, 226 Federal Reserve, 9, 23, 24, 39, 47, 66, 67, 75, 80, 100, 102–104, 109, 118, 130, 141, 151, 178, 180, 194, 197, 212, 218, 242 Fixed exchange rates, 6–8, 10, 22, 35, 36, 42, 48, 50, 51, 55, 56, 59–61, 66, 70, 73, 74, 87, 88, 105, 144n23, 168–170, 175, 180, 198, 212, 223, 244 Flanigan, Peter, 105 Fleming, Marcus, 44 Flexible exchange rates, 6, 7, 36, 37, 44, 87, 88, 144n23, 164, 198, 224, 236, 243–245 Ford Foundation, 70 Ford, Gerald R., 11, 183, 205, 206, 210, 211, 219 Forest City Hospital, 20


“A Formal Model of the Economy” (Laffer and Ranson), 93–111, 126, 135, 170, 180 Fortune 500, 20, 31, 137, 234, 239 France, 77–79, 81, 142, 164, 214, 215, 240 Frankfurt School, 24, 26, 150, 152 Free-banking years, 88 Friedman, Milton, 3, 5, 6, 36–38, 44, 50, 66, 70–72, 85, 95, 96, 98, 104–107, 118, 131, 141, 157, 158, 163, 164, 167, 180, 181, 215, 219, 221, 244 G Galbraith, John Kenneth, 25 Gates, William H. III, 236 Gavin, Francis J., 148 General Motors strike (1970), 115, 125, 128 Giscard d’Estaing, Valery, 78 Glazer, Nathan, 209 Gold overhang, 48, 49 Gold Pool, 75, 77, 79, 164 Gold standard, 9, 28, 36, 37, 43, 47, 83, 88, 139, 142, 150, 151, 164, 171, 176, 216 Goldwater, Barry, 37, 38 Goodbye, Columbus (Roth), 1–3 Goodyear, 2 Gordon, Kermit, 73 Gordon, Robert J., 137 Graham & Dodd Scroll Award (Financial Analysts Journal), 167 Gresham’s law, 86 “Growth and the Balance of Payments” (Mundell), 12, 39, 41–62, 68, 69, 72, 156, 161, 162, 171 Growthmanship, 62 Gurley, John, 32



H Haberler, Gottfried, 36, 182 Hance, Kent, 156 Hansen, Alvin, 36 Harberger, Arnold, 44, 157, 190 Harberger triangle, 27, 190, 213 Harrington, Michael, 110 Hawken School (Shaker Heights, Ohio), 21 Hayek, F.A., 7, 8, 44 Hegelianism, 26, 149, 151 Heller, Walter, 22 Hong Kong, 162, 244 Houthakker, Hendrik S., 142 Hume, David, 73 Humphrey-Hawkins Act, 219 Hynes, J. Allan, 71 I Ibbotson, Robert G., 159 Institut für Sozialforschung (Frankfurt am Main), 24 Instructional Dynamics, 119, 122, 131, 163 Intermetall, 21 International Economics (Mundell), 55, 63n4, 189 International financial intermediation thesis, 7, 41, 52, 155 International Monetary Fund (IMF), 12, 42, 44, 47–49, 57, 68, 69, 72, 79, 82, 144n23, 151, 162, 163, 170, 173n16, 212, 225 ITT, 32 J Jackson State University, 130 James, Harold, 148, 149, 152, 230 James, William, 138

Jobs, Steve, 154 Johns Hopkins University, 42 Johnson, Harry G., 36, 44, 70, 71, 73, 138, 224–229 Johnson, Lyndon B., 75, 77, 86, 148, 176, 194 Joint Economic Committee, 49, 117, 147, 218 Jorgensen, Earle, 233 Jorgensen, Marion, 233 Journal of Business, 93, 170 Journal of Finance, 93, 106, 158 Journal of Law & Contemporary Problems, 76 Journal of Money, Credit and Banking, 155, 161, 166 Journal of Political Economy (JPE), 8, 68, 85, 105–107, 217 K Kemp, Jack, 192, 193, 231, 232 Kenen, Peter, 73 Kennedy, John F., 17, 22, 23, 37, 42, 61, 62, 68, 69, 72, 99, 101, 109, 194, 207, 215, 217, 231, 233, 244 Kent State University, 101 Keynes, John Maynard, 4, 5, 13–14n3, 32, 36, 79, 82, 111, 216, 241 Keynesianism, 4–7, 9, 15n9, 30, 35, 40n13, 72, 94, 96, 108, 111, 121, 178, 193, 196, 210, 212, 215–217, 220, 236, 242 Kindleberger, Charles, 42, 46, 50, 52, 79, 80 Klein, Lawrence, 97 Kleiner, Eugene, 32 Kristol, Irving, 209 Krugman, Paul, 127–129 Kuhn, Thomas S., 71, 152


L Laffer, Arthur B., 3, 4, 17, 41, 65, 93 Laffer curve, 11, 12, 27, 57, 60, 82, 159, 175–186, 206–208, 211, 222, 231, 241 Laffer, Mertice, 20 Laffer, Molly, 17, 19, 20, 138, 177, 179, 205, 239 Laffer, Patricia, 152 Laffer, William G., 17–21, 138 Lags and leads in macroeconomic variables, 95 Lamarr, Hedy, 154 LaRue, Joseph, 134, 135 Late capitalism, 4, 26, 110, 215 Laurel Academy (Shaker Heights, Ohio), 21 Lee, Moon Hoe, 167, 181, 198, 210, 240 Leeson, Robert, 36, 136, 163, 164 Legitimation crisis, 80, 195 Liquidity trap, 4, 13n3, 110, 111, 215, 217, 220, 221 Löwenthal, Leo, 26 M Machlup, Fritz, 36, 86 Mann, Maurice, 33 Marshall, Alfred, 32, 187 Martin, William McChesney, 67 Marxism, 29, 30, 38 Massachusetts Institute of Technology, 42, 119 Matusow, Allen J., 100, 101 McCormick, Cyrus, 154 McCracken, Paul W., 98, 100, 102–105, 116–118, 123–127, 129, 130, 177 McGill University, 42, 68


McKinnon, Ronald I., 32, 33, 45, 55, 57, 59, 68, 69, 74, 139 Meade, James, 36 Mechanics Educational Society of America (MESA), 18 Mehrling, Perry, 158, 219 Meltzer, Allan H., 106, 130, 168, 177, 178, 182 Metzler, Edith, 132 Metzler, Lloyd, 132 Michael 1 (restaurant), 191–197, 216, 231, 239, 242 Mill, J. S., 62 Miller, Merton, 44, 93 Misery index, 178, 191 Moggridge, D. E., 138, 226–229 Monetarism, 4–7, 9, 36, 85, 94–96, 123, 131, 177, 178, 205–236, 242 Monetary approach to the balance of payments, 224, 226, 227 Monetary order vs. system, 81 Monetary Theory (Mundell), 56, 82, 150 Montesquieu, 216 Moore, Gordon, 32 Morgan Stanley, 31–33, 234 Multiplier, 96, 98, 103, 193, 213, 215 Mundell, Robert A., 3, 9, 10, 12, 13n2, 15n9, 35, 38, 39, 41–44, 46, 47, 52, 55–62, 67–73, 77–83, 85–87, 89, 99, 140–143, 144n23, 147–150, 152, 153, 156, 157, 161, 162, 164, 167, 169–172, 176, 177, 179–182, 184, 189–193, 195, 197–201, 206–212, 214, 215, 218, 222, 223, 225–227, 229–232, 236, 239–242 Mussa, Michael, 72 Musto, David, 209



N National Bureau of Economic Research (NBER), 151, 165 National Income and Product Accounts (NIPA), 85 National Observer, 160 National Science Foundation, 135 Nelson, Gaylord, 222 Nerlove, Marc, 32 New Deal, 14n9, 153, 208 New Economics, 22, 68, 99, 111, 192 New history of capitalism, 153 Newsweek, 162, 163 New York Times (NYT), 99, 115–117, 120, 139 Nixon, Richard M., 11, 14n5, 19, 93, 94, 100–102, 104, 108, 109, 115, 116, 118, 120, 123–126, 129, 130, 135, 139, 140, 154, 156, 157, 162–164, 182, 218, 227, 231, 232, 235 Noonan, Peggy, 192 Novak, Robert D., 193 Noyce, Robert, 32 O Obama, Barack, 208 Office of Management and Budget (OMB), 4, 11, 33, 85, 93, 94, 98–108, 111, 117, 118, 122, 124, 135, 137, 154–157, 159, 160, 167, 183, 198, 210, 213, 220, 222, 232 Oil shock, 176, 199, 200, 242 Okun, Arthur, 22, 23 Operation Twist, 23 Organization of Petroleum Exporting Countries (OPEC), 199, 200 P Palos Verdes Estates (California), 233 Parker, Charles, 160, 191, 239

Pechman, Joseph, 73, 132, 133 Perlstein, Rick, 209 Peterson, Peter G., 142 Phenomenon of Worldwide Inflation (Meiselman and Laffer), 181, 215 Pollock, Friedrich, 24 Postwar prosperity, 2–6, 8–10, 31, 242, 245 Pound sterling, 33, 77, 80, 244 Prasad, Monica, 14n9, 193 Princeton University, 36, 39, 143 Procter & Gamble, 2 Proxmire, William, 127 Public Interest, 209, 210, 213 Q Quarterly Journal of Economics (QJE), 68, 69, 107, 217 R Rancho Santa Fe (California), 138, 233 Ranson, R. David, 94–99, 103, 104, 107–109, 111, 117–119, 122, 123, 126, 129, 157, 167, 170, 171, 183, 188, 213 Rawls, John, 235, 238n30 Reagan, Nancy, 12, 236 Reagan, Neil “Moon,” 138, 233, 234 Reagan, Ronald, 11, 12, 35, 83, 131, 156, 183, 192, 206, 208, 210, 220, 232, 233, 241–243, 245 Recessions, 5, 8, 11, 23, 67, 98, 101–103, 108–110, 115, 117, 125, 130, 155, 156, 165, 170, 178, 194, 199, 205, 206, 219, 222, 242 Reuss, Henry, 147–149, 218 Reynolds, Alan, 231 Richards, David, 160 Roberts, Paul Craig, 192 Robinson, Joan, 79, 110, 111 Rockefeller Foundation, 70 Rockefeller, John D., 20, 196, 234


Roosevelt, Franklin D., 81, 140, 208, 214 Rose, Francis, 156 Roth, Philip, 1, 2 Rowen, Hobart, 117–121, 124, 125 Rubik’s cube, 11, 183 Rueff, Jacques, 179 Rumsfeld, Donald H., 11, 153, 191, 211 Russell, Bertrand, 98, 126 Rutledge, John, 201 S Sachs, Goldman, 158 St. Louis model, 97, 98, 103, 105, 107, 123–125 Salant, Walter S., 46, 50–54, 57, 73, 74, 79, 182, 231 Salvatori, Grace and Henry, 233 Samuelson, Paul A., 32, 36, 37, 54, 104, 119–127, 130–134, 137, 139, 142, 178, 190, 202n5, 226 Sargent, Thomas, 194, 196, 236, 242 Say, J.-B., 216 Schultz, Theodore, 44, 70 Schwartz, Anna J., 66, 106 Scitovsky, Tibor, 36, 54, 139 Selden, Richard, 157 Seven Fat Years (Bartley), 181, 192, 195, 198, 199, 210, 239 Shadow Open Market Committee (SOMC), 106, 107, 177, 178, 182 Shaw, Edward S., 32, 45, 54, 74, 139, 159 Shelton, Judy, 47 Shiller, Robert J., 11, 183, 191 Shockley Transistor, 32 Shockley, William, 18, 32, 240 Shultz, George P., 4, 11, 44, 89, 93, 94, 99, 100, 103–105, 116, 117, 120, 122, 124, 126, 127,


129–131, 135, 143, 153, 156, 160–163, 173n16, 211, 214, 222, 223 Silber, William, 104, 105, 107 Silicon Valley, 8, 19, 32 Silk, Leonard S., 116–125 Simon, William E., 153, 200, 211–214 Sinquefield, Rex, 159 Slevin, Joseph, 124–126, 131 Slutsky, Eugen, 167, 169 Snake (monetary arrangement), 155 Solow, Robert M., 22, 61, 178 Special Drawing Right (SDR), 82 Stabilization policy, 67, 69, 70 Stagflation, 8–13, 35, 82, 83, 107, 133, 142, 143, 151, 154, 165, 169–171, 176, 178, 179, 181, 182, 191, 192, 195–197, 199, 205, 208, 209, 211, 217, 223, 228, 230–232, 234, 236, 240, 242, 243, 245 Standard Oil, 2, 20, 196 Stanford University, 4, 24, 135 Steele, Jack, 232 Stein, Herbert, 100, 103, 104, 123, 125, 127, 182, 231 Stein, Jerome L., 33–36, 38, 51, 61, 75, 86 Stigler, George J., 37, 38, 44, 89, 134–136, 157, 196, 218, 222, 223, 226, 227, 239, 242 Stock market, 95, 101, 103, 122, 130, 196, 206, 208, 242 Stockman, David, 210 Supply-side economics, 12, 13, 14–15n9, 17, 27, 60–62, 65, 83, 99, 109, 153, 182, 192, 229, 231, 241, 245 Sweezy, Paul M., 24, 25, 29, 220, 221, 241 Szell, George, 240



T Taft, Robert A., 19, 21 Tarshis, Lorie, 32 Taxes, 7, 9–12, 19, 20, 25, 27–30, 40n1, 57, 60–62, 67–69, 143, 153, 159, 161, 171, 172, 176, 182, 183, 185–190, 192, 193, 195, 197, 200, 201, 202n13, 206–208, 210–213, 215, 217, 219–222, 225, 231, 233, 234, 241, 243–245 Teigen, Ronald, 106 Tesla, Nikola, 154 Texas Tech University, 156 Thornber, Hodson, 160 Thornber, Judy, 160, 239 Thornton, Charles “Tex,” 232 Tinbergen, Jan, 36, 169 Tobin, James, 22, 23, 29, 30, 36, 38, 39, 56, 68, 107, 111, 195, 217, 218 Toilet paper, shortages of, 165 “Trade Credit and the Money Market” (Laffer), 85, 86, 105 Transfer problem, 189, 241 Triffin, Robert, 49, 50, 62, 81, 175, 214, 215 Truman, Harry S., 39 Trump, Donald J., 47 Tuttle, Virginia and Holmes, 233 “Two Arguments for Fixed Rates” (Laffer), 14n6, 86, 87, 91n27 Two Continents (restaurant), 182–190, 205–207 U University of Chicago, 3, 5, 33, 39, 41, 44, 46, 70, 131, 133, 136, 147, 152, 156, 160, 191, 224–226, 232

University of Chicago, Graduate School of Business, 39, 65, 89, 93 University of Southern California, 11, 12, 160, 232 University of Waterloo (Ontario), 152 University School (Shaker Heights, Ohio), 21 United States Bullion Depository at Fort Knox, 48 V Vietnam, 94, 110, 111, 177 Volcker, Paul, 104, 142, 242 Von Neumann-Morgenstern utility function, 27 Von Neumann Whitman, Marina, 224, 229–231, 236, 243 W Wainwright, H.C. and Co., 160, 191 Wall Street Journal (WSJ), 11, 82, 115, 128, 153, 160, 169, 175, 192, 193, 223, 231 Walras, Leon, 42 Wanniski, Jude, 11, 15n9, 41, 42, 82, 160, 161, 165, 175–184, 190–193, 195, 196, 205–213, 216, 217, 223, 229–232, 237n5, 239, 240, 243 War Production Board (United States), 18 Washington Post (WP), 115, 117 Watergate, 129, 130, 210 Wedge, 29, 171, 188, 190, 199, 200, 212, 213, 216, 219–222, 231, 232, 245 Western Reserve University, 22 Westinghouse, George, 154 Wharton model, 97


White, Harry Dexter, 82 “Why They Are Laughing at Laffer” (Samuelson), 119, 120, 124, 130, 131, 139, 143n6 Williamson, Jeffrey G., 57, 60, 88 Wilson, James Q., 209 Wilson, John, 136

Workshop (Chicago economics), 4, 70, 71 Y Yale University, 17, 49 Yom Kippur War, 242 Youngstown, Ohio, 3, 17