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11/4/92


TITLE #m#ak/tlj#m#Economist Lawrence Kudlow: He's Keeping The
Supply-Side Faith Alive On Wall Street Kathleen Hays In New York
Wall Street economist Lawrence A. Kudlow needs just one lens to
view the world clearly: the free-market principles of supply-side
economics.


The phrase "supply-side economics" came into vogue with the
changes ushered in by the Ronald Reagan-led revolution of the
1980s that championed lower taxes and less government regulation
as the magic formula for growth. Kudlow served as one of the foot
soldiers in the heady first days of that popular administration.
Today, many economists charge that the supply-side views promul-
gated by Reagan's disciples in the 1980s left a woeful legacy of
swollen federal deficits,

a battered banking system and a stagnant economy.  Kudlow, who
practices his craft as chief economist of Bear, Stearns & Co.,
see below

could not disagree more.  He says that supply-side policies laid
the foundation for the long economic expansion of the 1980s, only
to be undermined when Reagan allowed the nation to start moving
away from these principles in his second term and President Bush
abandoned them over the past four years.  "The Bush administra-
tion gave up on incentive economics," he said in a recent inter-
view. "They inadvertently moved from expansionary to contraction-
ary policy." "They didn't understand what they were doing. I
still don't think they understand," Kudlow said.  Kudlow should
know. He spent three years, from 1981 through 1983, as associate
director for economics and planning at the Office of Management
and Budget, serving as deputy to budget director David Stockman.
Stockman later repudiated Reagan's economic program, and left the
White House team to join Wall Street's Blackstone Group, the in-
vestment banking house headed by top Clinton adviser Roger Alt-
man.  In contrast to Stockman, Kudlow remained true to the cause.
It's a


Kudlow Keeps The Supply-Side Faith Alive

commitment that he claims helped him develop a wide following on
Wall Street. In a recent poll by Institutional Investor, bond
market investors voted Kudlow the No. 2 economist on Wall Street.
Equities investors put him at No. 3.  While many economists point
to an eclectic assortment of theories to explain their views,
Kudlow argues that supply-side principles are more than ample to
understand the way the economy works - and to make the accurate
forecasts that investors need to make money.

Valuable Ideas

"I think of myself not as a great theoretician, but from a prac-
tical sense in the real world I could see why these ideas were
valuable," he said, explaining why he began to embrace and use
supply- side tenets in his economic forecasting work in the late
1970s.  Kudlow, a Democrat during his undergraduate days at the
University of Rochester in New York, traces his evolution toward
the supply side back to his years at Princeton University's Woo-
drow Wilson School of Public and International Affairs, from
which he graduated in 1973 with a master's degree in public af-
fairs.  He decided that he wanted to work for either the Treasury
Department or the Federal Reserve because of the dramatic changes
underway in the domestic and global economy - including the
breakdown of the Bretton Woods system of fixed exchange rates in
1973.  "I was interested in these changes because the whole econ-
omy seemed to be going awry and the Keynesian models we were
taught in school didn't seem to be working," he said.  Kudlow got
his wish, serving 21/2 years at the New York Fed, where he worked
on bank regulation, economic analysis, and the execution of daily
monetary policy actions on the Fed's open-market desk.  Kudlow
left the Fed to work in the newly formed fixed-income research
department at PaineWebber Inc. He was wooed away four years later
by Bear Stearns in 1979. Although the firm was small at the time,
"they were an aggressive bunch of people and I fit right into
it." In the meantime, Kudlow had begun to use supply-side princi-
ples in his work, basing a bearish interest rate and inflation
forecast in the late 1970s on the then-steady rise in gold
prices.  "I argued (at the time) that inflation and the economy
would get worse until there was a change in national economic
policy," Kudlow said. "I think at the time I was just about the
only guy on Wall Street using this stuff." "I had been moving on
the supply side for several years and believed strongly that the
tax rate had to be reduced, that inflation had to be reduced, and
I was an advocate of linking the dollar to gold and stabilizing
the value of money," he said.  Kudlow explained that the interac-
tion of the tax system and the "great inflation" of the late
1970s combined to create "bracket creep" - which pushed individu-
als into ever-higher tax categories and robbed "the economy of
its basic capital-forming and productivity incentive."

No surprise then, that during those years Kudlow voted for two
Republican presidents, Gerald Ford in 1976, and Reagan in 1980.
"It was clear to me that the ascendancy of Reagan moved the
Republican party to supply- side principles," Kudlow said. "What
struck me was how clear Reagan was. He was specific on the is-
sues, and I was turned on to it." In 1980, just after being made
partner in Bear Stearns, a meeting with David Stockman to discuss
the economy and financial markets shortly after Reagan's election
led to an invitation to spend a few weeks in Washington to help
hammer out the new budget. The few weeks led to an offer to serve
as Stockman's chief economist at OMB.

Important Chance

The decision to leave Bear Stearns was difficult, but he went for
it. "It was a chance to put into policy things we were talking
about in the private sector," he said.  One of the toughest times
for Kudlow came late in 1982 when Reagan's economic advisers
split over what to do about the long, deep recession of 1981-82.
"We had been in office for two years and the recovery had not
started," Kudlow said, although he argued that the 1981 tax cuts
and the drop in inflation would kick in and the economy would
soon take off.  "When the recovery came on in the winter and
spring of 1983, it came on faster than people thought," he said.
"It was definitely a moment for me not just as a policymaker but
as a forecaster. The fact is it locked in, for me, the validity
of the supply side."

Kudlow left OMB in 1983 and set up shop in Washington as a
private consultant on economics and finance. After three years,
he returned to Bear Stearns as chief economist.  Looking back,
Kudlow is critical of Reagan's second term, mainly for the
dollar-depreciation policy pursued by the Treasury Department,
which he says was unnecessary. But he also criticizes the in-
creased tax burden placed on capital by the landmark 1986 tax re-
form.

As for Bush, "I think that Bush's first term as far as economic
policy is concerned was just a series of mistakes. At every fork
in the road, Bush's economists took the wrong fork." Kudlow is
especially critical of the steps taken starting in 1989 to deal
with the savings and loan crisis.  He charges that the adminis-
tration was "far too overzealous and punitive in new regulations"
and ended up delivering "a significant curtailment of credit . .
. (which was) a major economic circuit breaker in 1989 and 1990."
In addition, Bush's team "never generated a sound pro-growth tax
policy," and made the tragic mistake of putting "the goal of de-
ficit reduction ahead of economic growth." "You can never reduce
the deficit without growing the economy," Kudlow said. "They end-
ed up increasing taxes in a recession." "By putting deficit
reduction ahead of growth, they eviscerated Reagan's supply-side
policies," he added.  One institution that has won high marks
from Kudlow over the past 12 years is the Federal Reserve.

Lauded For Policy

While some economists criticize the Greenspan Fed for following a
stern anti- inflation policy, which they argue helped to prolong
the current economic slowdown, he lauds them for moving toward a
de facto policy of linking monetary policy to gold in order to
achieve the price stability needed for firms to prosper.  "I
think inflation expectations would be lower if gold were more ex-
plicitly linked to monetary policy," he said.

Looking ahead, Kudlow said the economy "will muddle along until
we get better growth policies." "The bright side is that we have
low interest rates and low inflation, but the business and in-
vesting (community) wants to see which direction tax policy
takes," he said. "People will supply capital if they see adequate
rates of return and withhold capital if they don't."

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