Larry Kudlow

It is now clear that the fog of war and a rise in energy prices threaten to block the economy from any significant upward movement this year. The current economy appears to be growing just short of 2 percent in real terms (or inflation-adjusted). That's unacceptably low growth.

The U.S. government doesn't update gross domestic product on a monthly basis, but these estimates -- based on growth rates of industrial production and personal income -- are reasonable proxies for GDP. And in a recovering economy, GDP should be running closer to 5 percent.

A relatively swift resolution of the impending invasion of Baghdad and the forcible removal of Saddam Hussein's regime over the next few weeks would certainly be a plus for U.S. business and job conditions. A newly privatized free-market oil sector in Iraq -- one that could end the Saudi/OPEC hegemony over oil prices and production -- would translate to falling power prices and contribute a tax-cut effect to the U.S. economy (even though such a development would be several years off).

But the critical element to putting this economy back on the path of vibrant growth is domestic economic policy. Washington must shift toward easier tax rates and maintain a program of accommodative money in order to rebuild decimated stock market wealth and reinvigorate investment in job-creating capital goods.

Recent increases in commodity prices, including gold, suggest that the Federal Reserve is doing its job on the monetary side. Deflation has been halted. But Greenspan & Co. must keep pouring sufficient quantities of new cash into the pipeline to ensure that there's enough liquidity to fund more rapid economic growth.

That said, the determining factor in a growth revival for next year is likely to be President Bush's proposal to reduce personal tax rates and eliminate investor dividend taxes. Senate Republicans now need to organize a working majority to match GOP approval of the president's plan in the House. To do this, they should employ the argument that the tax cuts now on the table will ameliorate the capital shortage that is holding back business expansion. In addition, they must make the case that war costs are best financed by revenues streaming into the government as a result of an economic growth-shift in the direction of full employment.

Two presidents in recent history understood this argument well.

Larry Kudlow

Lawrence Kudlow is host of CNBC’s “The Kudlow Report,” which airs nightly from 7 p.m. to 8 p.m.