FORGET KIM--STOP KOHN:

Federal reserve wars (Robert Novak, November 6, 2003, Townhall)

Although today's Federal Reserve is almost transparent when compared with its opaque past, what goes on behind closed doors in its marble palace remains cloaked in mystery. The events last week were especially shrouded by Greenspan's desire to avoid the impression of controversy in his final years and an important doctrinal debate between two remarkable new Fed governors.

These two governors both took office Aug. 5, 2002, ending years of humdrum appointments to the central bank that reflected Greenspan's wishes. One new governor was Ben Bernanke, the 48-year-old chairman of Princeton University's economics department and the most distinguished economic theorist on the Federal Reserve Board in recent memory. Bernanke was a rare Fed nomination originated in the White House, not by Greenspan. The other new governor was 59-year-old Donald Kohn, a Fed staffer for 35 years and Greenspan's right-hand man the last 15.

Bernanke has long advocated setting inflation targets to determine whether the central bank should tighten or loosen. Not wishing to offend Greenspan, the rookie governor has argued that this will help the next chairman, who would lack the magical finesse of "the maestro." An inflation standard would threaten the central bank's aura of mystery and its world-famous staff's actual power. Kohn, who did not become only the third member of the Fed's bureaucracy ever to be a governor just to preside over its diminution, opposes targeting inflation.

Bernanke vs. Kohn is no mere theoretical debate. Greenspan, blamed by Republicans for contributing to the first George Bush's 1992 defeat by tightening money, does not want to doom re-election chances of the second President Bush by snuffing out the recovery -- particularly after the president extended his tenure to 2006. Kohn and the Fed staff want to tighten whenever the economy grows -- the old Phillips Curve -- even if inflation continues to fall, as is now happening. A showdown was set for the FOMC meeting of Oct. 27.

It took even the Maestro almost twenty years to figure out that deflation was a problem and inflation not. In the meantime, he kept rates absurdly high and stifled the economy at times (as in 2000 and 2001). If Mr. Kohn has a similar learning curve he's the most dangerous man in the world.

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Rising to the occasion (Larry Kudlow, November 6, 2003, Townhall)

In the two decades prior to the technology boom, the ravages of high inflation, skyrocketing interest rates, over-regulation and high marginal tax rates contributed to a measly 1.5 percent average annual increase in productivity, or output-per-hour. But over the past eight years, the application of innovative technologies -- spurred by a wave of capital investment -- has generated a 3.2 percent yearly gain in productivity through boom and bust. This productivity miracle has made the U.S. economy incredibly efficient. It has also enabled businesses of all sizes to slash costs and raise profits. The workforce has never been better equipped, and real wages keep rising.

Economists calculate the nation's potential to grow by adding productivity gains to average population growth rates. In the United States, population tends to rise at a 1 percent rate, so the new-era Internet economy is capable of growing in a sustained long-term fashion at roughly 4.2 percent a year (3.2 percent productivity plus 1 percent population growth). In the old-economy era, America's capacity to grow was only 2.5 percent a year.

Over the next 20 years, the difference between 4.2 percent and 2.5 percent amounts to $6.4 trillion in higher national income. In budget terms, at an average 20 percent tax rate, roughly $1.3 trillion in new revenues will turn deficits into surpluses. At the same time, more growth, investment and work will operate to hold back inflation and interest rates.

While inflation is primarily a monetary phenomenon -- a lower dollar value caused by too much money chasing too few goods -- higher productivity and faster economic growth raise the supply of available goods and services that can be purchased with the same quantity of money. Hence, the existing money supply becomes less inflationary in a growth-producing, productivity-enhanced economy.

Posted by Orrin Judd at November 6, 2003 8:18 AM