ART LAFFER: I Was Wrong About Inflation And The Fed

Arthur Laffer is a legend in Washington, having been the leading voice on President Ronald Reagan’s hawkish Economic Policy Advisory Board.

His “Laffer Curve,” which argued that there are diminishing returns after a certain point of taxation, was taken as gospel.

If his views are not quite as frequent a presence in public debate, it’s largely because Laffer’s pet issues, regulation and taxes, took a back seat during the George W. Bush and Barack Obama administrations.

But Laffer himself still occasionally makes appearances on the public scene.

And in June of 2009, he penned an op-ed warning excessive quantitative easing would inevitably lead to higher inflation and interest rates.

…we haven’t ever seen anything like this in the U.S. To date what’s happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime interest rate peaked at 21.5% and inflation peaked in the low double digits …Gold prices went from $US35 per ounce to $US850 per ounce, and the dollar collapsed on the foreign exchanges. It wasn’t a pretty picture.

Obviously, nothing like that happened.

In an interview with Business Insider from his office in Tennessee, Laffer admitted that he was wrong. The old maxim that dictates increasing the availability of cash through lower interest rates will lead to higher prices, he said, may need to be reexamined.

“Usually when you find the model this far off, you’ve probably got something wrong with the model, not that the world has changed,” he said. “Inflation does not appear to be monetary base driven,” he said.

He’s not totally comfortable with what the Fed is doing, however. “Ask me whether inflation represents longer-term problem, I think there’s a potential there for excess reserves to create problems.”

But it now seems impossible to predict.

“I feel very uncomfortable with respect to looking at inflation,” he said.

Laffer remains critical of both the bank bailouts and QE, arguing both have held back job creation and the housing market. Left to its own devices, the economy always finds ways to recover, he said.

“If you look at [the] 2001-2002 [financial crisis], we barely had a decline in GDP, it corrected itself fairly quickly. The only other time we had intervention was in the 1930s. I think we had a Great Recession, and the reason we had a Great Depression, was because of intervention, not in spite of it.”

He now predicts Republicans will take over the Senate in 2014 — and in fact has consulted on recent campaigns. Anger over Obamacare, he said, will push them to victory. He drew a parallel between Jimmy Carter’s response to the 1970s’ energy crisis, which did nothing to alleviate demand for gasoline and President Obama’s approach to expanding insurance.

“You can’t give away healthcare and not expect the system to overuse it,” he said.

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