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Godfather of the Euro: A Conversation With Robert Mundell, Part 2

Nobel laureate Mundell shares his thoughts on how policymakers should fight inflation and how they should use the federal budget surplus.
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This wide-ranging interview between Nobel laureate economist Robert Mundell and Jack Egan, who follows the economy and financial markets for U.S. News & World Report magazine, began yesterday and continues here today.

Beyond being the economist most responsible for promoting Europe's new single currency, the euro, Robert Mundell is also known for helping parent supply-side economics. He was also a member of the conservative foursome that laid the foundation of what came to be known as Reaganomics in the 1980s. The group included economist

Arthur Laffer

(creator of the eponymous

Laffer Curve

, which describes how lowering tax rates will result in higher tax revenues),

The Wall Street Journal

editorial page chief Robert Bartley, and Jude Wanniski, then a writer for the

Journal

and now the head of

Polyconomics

, an economic consulting firm.

The group met weekly during the mid-1970s at a Wall Street restaurant and refined Mundell's prescription for dealing with stagflation through deep tax cuts and tight monetary policy. The policy was embraced by then-presidential candidate

Ronald Reagan

and ultimately became the centerpiece of his economic policy, Reaganomics.

Jack Egan: Inflationary expectations seem to be rising again for the first time in years. But do you think that inflation is actually rebounding?

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Robert Mundell:

At least on the surface -- that is what recent producer and consumer price numbers seem to indicate. Whether those jumps are due to unusual factors remains to be seen. We don't have enough information yet. But if you saw a repetition in coming months, that would demonstrate inflation was making a comeback.

Egan: So what's the policy prescription here if we do find that inflation's ratcheting up? The Federal Reserve has already been hiking interest rates, but won't that eventually slow the economy and lead to a weaker dollar and higher interest rates?

Mundell:

The best policy is to restore noninflationary growth, and to me the prescription for that would be to have an overall tax cut. If there's a slowdown in the economy -- due to lower consumer spending and therefore less demand for American goods -- then a certain reduction in the value of the dollar against other currencies wouldn't be an entirely bad thing because it would stimulate exports by making them cheaper.

Egan: The federal government is presently running a surplus of more than $100 billion a year. What do you think is the best way to deal with this surplus?

Mundell:

Not doing anything with it but simply using it to lower the country's accumulated debt burden can be a big benefit. If you're able to lower the ratio of accumulated debt to gross domestic product, that can improve the economy.

Egan:

How so?

Mundell:

It's something that nobody thinks of. The lower the debt is today, the higher it could be in the future. Suppose you have another economic emergency, another big war to fight. If you're already choking with debt like Europe -- and Italy in particular, with accumulated debt at 125% of its

GDP

-- then there's little leeway to borrow when you need to. But there's maybe a good side to that dilemma: It would be tougher to start a war.

Egan: Is economics today really a science?

Mundell:

It has to be, because they give Nobel Prizes for economics! Actually, the same principles apply as in the awards for chemistry and medicine: Economic theory is good or bad depending on how well it works. The Mundell-Flemming model

which says government-spending programs to boost an economy backfire when they cause interest rates to rise, known in the financial markets as ''crowding out'' predicted things people didn't think of before. Instead of trying to figure out inside your head what's going to happen, you have a model. You have the input and the output and you have a close relationship between them.

Egan: But isn't economic theory a little like forecasting the weather? There are so many variables involved.

Mundell:

We're a little ahead of meteorology. Economists can't answer everything, but they can answer hundreds and hundreds of questions, and these are very important questions.

Egan: Economics is sometimes called the dismal science. Do you think that's appropriate?

Mundell:

Yes, there is a dismal aspect. What's dismal is we haven't yet abolished poverty.

Jack Egan follows economics and domestic and global financial markets for

U.S. News & World Report

magazine.