31 Dec 2012

Murphy Inflation Smackdown

Daniel Kuehn, David R. Henderson, DeLong, Inflation, Krugman 94 Comments

[UPDATE below.]

Brad DeLong unleashes hell on me at his blog for my (price) inflation bet with David R. Henderson. Especially in light of my Les Mis post yesterday, I had thought about either ignoring this or just linking to it in a Potpourri with no comment. However, at the risk of seeming petty, I think there really is a major issue here that none of the Austrians have brought up (in the comments of my Facebook post, for example, when I linked to DeLong with only the wisealeck comment that I have never before been attacked with so many adverbs). So here are my quick reactions:

==> I screwed up. I obviously wish I had never made that bet with David, since (a) it looks like I’ll be out $500 and (b) what is worse, my error gives ammunition to people like DeLong who want to challenge my policy conclusions and Austrian economics more generally.

==> DeLong accompanies his post with a chart of year/year percentage changes in core CPI. Well, that’s stacking the deck. The bet was about headline CPI, which almost hit 4%. Nowhere near what I needed, of course, but much better than DeLong’s chart would indicate.

==> The comments section is funny. You would think amidst everyone’s psychoanalysis of me, they could acknowledge my presence. I think they ignored me though because that makes it harder to speculate on what an idiot and a liar I am. (I’m being serious, that comment section is odd right now.)

==> Speaking of the above, to the extent that my preferences matter to you guys, please don’t bash the heck out of DeLong in the comments here. Makes it harder to play the victim card.

==> Finally my substantive point: I have never seen any of these guys explain why price inflation (and interest rates) are the decisive criteria for whose model and hence policy recommendations are right. Consider, for example, the infamous Christina Romer unemployment graph, showing what would happen with and without the Obama stimulus package. As far as I know, DeLong didn’t ask Romer to announce to the world that she had been wrong about everything and to spend years at the feet of Joe Salerno. No, Daniel Kuehn for example thought that anyone who wanted to use the Romer forecast as a test of the efficacy of her model was putting out “complete horsesh*t.”

So I’m not saying the following–like I said, I screwed up in a way that is relevant for economists talking to the general public. But since the following is exactly analogous to how Keynesians deal with the unfortunate Romer situation, I’m curious why they think Austrians who warned of large price inflation can’t say the following:

Hey, it’s true, we threw out some predictions of how much prices would rise, and we were off. But our basic model wasn’t wrong, it was just the underlying forecast of the baseline. Bernanke really did create a bunch of price inflation, it’s just that in the absence of Fed action, the drop would have been bigger than we expected, so on net we didn’t see as large of an increase in absolute terms. Indeed, Krugman et al. agree with the economic model involved: they all congratulate Bernanke for having staved off massive price deflation. So what’s the argument here? We’re arguing about the counterfactual of price movements in the absence of Fed monetary inflation.

Seriously, how is the above any different from how Keynesians defended Christina Romer, to the point of saying anybody who thought her prediction should be used against her was intellectually dishonest?

UPDATE: In case someone is tempted to say, “Oh sure Bob, Romer screwed up the unemployment forecast, but Krugman and some other Keynesians nailed it, showing that the Keynesian model is OK…” Fine, I’ll point to Mish, a super-free-market guy (not sure if he formally embraces Austrian economics per se) who has been calling for deflation since the crisis set in. So why doesn’t the example of Mish (and there are others) rescue free-market critiques of Big Government?

For that matter, David R. Henderson isn’t a Keynesian, and he was the one who took the other side of the bet. (Bryan Caplan even went further and gave me a longer time frame.) David and Bryan don’t call themselves Austrians, but they’re not Keynesians either. Doesn’t anyone see how absurd this is? It would be like pointing to Krugman’s critique of the stimulus as being inadequate, and saying it proves our recession is a supply-side problem.

94 Responses to “Murphy Inflation Smackdown”

  1. Brad DeLong says:

    If you were to say “our underlying forecast of the baseline. Bernanke really did create a bunch of price inflation, it’s just that in the absence of Fed action, the drop would have been bigger than we expected”, I would say: yes, you have got it exactly. Had Bernanke held the Federal Reserve’s balance sheet at $700B rather than raising it to $3T, we would now be having deflation–the price level now would be some 10% lower than it is, with absolutely horrible and disastrous consequences for output and employment.

    Few people doubt that Bernanke’s lowering short-term rates from 5% to 0% was an inflationary policy–that doing so created a lot of inflation relative to baseline. There is dispute about whether and what quantitative easing and forward guidance really do, if anything–cheap talk and swaps of two assets that are very close substitutes after all. But keep saying that lowering interest rates from 5% to 0% has had a substantial impact on the post-2007 course of the price level and I will cheer you on.

    • Bob Murphy says:

      Do I still have to sit at the feet of Krugman?

      • Daniel Kuehn says:

        I wonder if that line was a crack at all the Krugman Kontradiction posts over the last four years…

    • Gamble says:

      Brad Delong wrote: “we would now be having deflation–the price level now would be some 10% lower than it is, with absolutely horrible and disastrous consequences for output and employment.”

      If some prices do not come down, how to you call it an economy?

      Why do you think all prices must go always go up?

      If prices would be down 10% absent Fed action, is that not the same as saying the Federal Reserve has created massive inflation resulting in 20% price increases?

    • Matt Tanous says:

      “he price level now would be some 10% lower than it is, with wonderful and grand consequences for output and employment.”

      Fixed that for you.

  2. Yosef says:

    Bob. look on the bright side. In Krugman’s post in which he links to DeLong’s post about you he names and shames Greg Mankiw, Brian Riedl, and Alan Greenspan, but he dares not speak your name. You’re getting to him!

    • Bob Murphy says:

      Man I didn’t see that yet. Hilarious.

      • Yosef says:

        Ouch, sorry Bob but I guess I spoke too soon. Krugman is out with a new post specifically about you: http://krugman.blogs.nytimes.com/2012/12/31/on-not-learning-continued/

        • Bob Murphy says:

          I can die now, again.

          • Yosef says:

            Will you be born again, again? Now in the light of the Over-Lord?

            • M. Krebs says:

              What are you people, 12 years old?

              • Ken B says:

                Separate, or combined?

              • Major_Freedom says:

                Did your parents or your siblings belittle you for your age while you were growing up too?

        • Jason B says:

          “The fact is that while Keynesians predicting a fast recovery weren’t really relying on their models, the failure of that fast recovery has nonetheless prompted quite a lot of soul-searching and rethinking. It is now standard, in a way that it wasn’t before, to argue that recessions that follow financial crises have a very different time path of recovery from other recessions, and that debt overhang, in particular, poses special problems.”

          The Romer/Bernstein recovery predictions weren’t based on their models? I honestly don’t know what to say.

          With regards to large amounts of debt overhang, no mention of the policies that lead to that?

          • Major_Freedom says:

            No no no no, the Romer model was not based on Keynesian theory. It can’t be, because Keynesian theory is correct.

            • Jason B says:

              Exactly. And listen, I’m not bagging on Krugman for his theory here. I honestly don’t mind his theory as much as some do. I’m bagging on him because of his overwhelmingly premature predisposition to completely manipulate his own perception of reality to suit his ideology.

              I read Krugman about once a week, and he never fails to oblige me by presenting himself in a manner that only Obama could fully communicate; that of an enlightened, always above the fray, non-partisan, I have the best interest of the country at all times douche.

    • Matthew M. says:

      Yet Krugman goes on to say “But we don’t have to go to hard-liners and marginal figures to find people who refuse to learn.” Ouch. Looks like we’re going to need to raise a lot more money. Surely there are some libertarian millionaires out there…

  3. Steve Horwitz says:

    The most important point here Bob is your last one: you made a bet with another economist whose ideas overlap significantly with those of Austrians (and who is essentially as “free market” as you are). The debate here was, in my view, about the importance of the demand for money (especially bank reserves).

    You and I might have the same basic Austrian model in our heads, but if I believed the demand for money, or the demand for bank reserves, was going to continue to grow as the Fed expanded the base, then I would take David’s side of the bet, not yours.

    As I read Brad’s comment above, and what he quotes of yours, I think we’re all saying the same thing. In my view, what you were wrong about is underestimating the demand for money/bank reserves. That doesn’t invalidate Austrian models (at least not ones that understand that the demand for money matters for inflation ;) ), and it certainly doesn’t invalidate “free market” criticisms of current policy, given that it was David on the other side of the bet.

    One interesting question, though, is to what degree that demand is independent of Fed policy. For example, the decision to pay interest on reserves certainly matters here. My take is that it shows that what Bernanke was up to was trying to *avoid* price inflation by making reserves more desirable to hold on the margin. All of the expansion of the base was not primarily about changing the money supply per se, but about “rescuing” the banks by buying up the crap on their balance sheets, and doing so in a way that wouldn’t send prices through the roof.

    Of course what the Fed is going to do *next* remains an interesting question as those reserves have to go somewhere eventually.

    • Daniel Kuehn says:

      Right – and the thing is Bob even recognized the demand for money point in the 2011 post that Brad cited when he noted that flight to the dollar from the euro was increasing the demand for money.

      So it could be that (like Romer in late 2008/early 2009) Bob did not have enough information in late 2009. That seems unlikely to me because hey – it was late 2009!

      It could also be that he underestimated money demand.

      And that, I think, is the whole criticism. I don’t think anyone here is trying to criticize the market. Brad never mentioned it and I’m pretty sure Brad and Krugman like the market.

      They think that we really need to learn from this crisis that we need to take increased money demand and deficient aggregate demand seriously, and that that is one thing that Bob’s lost bet seems to be teaching us.

      • RPLong says:

        Can you clarify that last paragraph? Not sure how aggregate demand plays into this issue in this case. Not saying you’re wrong, I just don’t understand.

        • Gene Callahan says:

          Excess demand for money = deficient demand for other goods

          • RPLong says:

            But we are talking about a single sector, are we not? Or are we saying that the financial sector’s demand for cash holdings vs. other goods is what determines aggregate demand?

      • Bob Murphy says:

        Daniel Kuehn wrote:

        They think that we really need to learn from this crisis that we need to take increased money demand and deficient aggregate demand seriously, and that that is one thing that Bob’s lost bet seems to be teaching us.

        Right, just like Christina Romer’s botched forecast seems to be teaching us that big deficits destroy jobs.

        Oh wait, I just spouted bullsh*t… :)

        • Daniel Kuehn says:

          ???

          I talked about Romer in a response post (http://www.factsandotherstubbornthings.blogspot.com/2012/12/this-is-good-point-from-bob-murphy.html), and I gave three (well, 1a, 1b, and 2) responses to your bet here – one of which is equivalent to my response to Romer’s prediction.

          I’m very confused as to how you expect me to react to your bet except that you keep wanting to talk about Romer.

        • Daniel Kuehn says:

          The first sentence of my second paragraph of this comment leaves open the possibility that your case here is analogous to Romer’s.

          Is that REALLY the defense you want to use? Because it seems weak to me. I think it’s more likely that Steve has a point on the role of money demand and aggregate demand in your view of things.

        • yenwoda says:

          “So it could be that (like Romer in late 2008/early 2009) Bob did not have enough information in late 2009. That seems unlikely to me because hey – it was late 2009!”

          Right – plus of course you didn’t see Romer defending that initial forecast as more information became available, but Bob was sticking by his prediction two years later!

          • Bob Murphy says:

            Right – plus of course you didn’t see Romer defending that initial forecast as more information became available…

            Right, after it was obvious Romer’s forecast would be wrong, she didn’t defend it anymore. Did you see me taunting David last year? My gosh this is exhausting.

            • Justafed says:

              One important point to note about Romer’s forecast is that the underlying GDP data was, um, really crappy. I think the downward final revision in GDP for Q4 2008 was the largest in history, and all of 2008 was downwardly revised well after the fact. You might recall that during 2009 there was for a brief time a small cottage industry within Econ wondering why Okun’s Law had suddenly gone wrong, since unemployment had gotten so high for such a relatively small fall in GDP. Well, *that* anomaly sure got fixed up convincingly…

    • Bob Murphy says:

      Steve Horwitz wrote:

      In my view, what you were wrong about is…

      No, Steve, clearly the lesson here is: Don’t make bets with a guy who was studying the Fed before I was born.

      • David R. Henderson says:

        Bob,
        When were you born?

        • Bob Murphy says:

          1976

          • David R. Henderson says:

            Then you’re right. I started paying attention to the Fed after reading Milton Friedman’s work int the late 1960s.

            • David R. Henderson says:

              “in” not “int”

    • Justin Merrill says:

      This is what I find frustrating. The wrong predictions made by a couple people doesn’t invalidate the school of thought. There is nothing “Austrian” that predicts hyperinflation from a quadrupling of the monetary base. I don’t think it is Austrians who invented the “money multiplier” theory that is taught in basic macro textbooks (including Krugman’s own). I’m an Austrian and correctly predicted that QE wouldn’t be massively inflationary or effective while banks repair their balance sheets and Operation Twist keeps the yield curve flat.

      It’s not Austrian models that failed, it’s the money multiplier myth that failed. Those who are Rothbardians on monetary theory are prone to adhere to that myth and also ignore the demand for money though.

      • Adrian Gabriel says:

        “Those who are Rothbardians on monetary theory are prone to adhere to that myth and also ignore the demand for money though.”

        And how so Justin? You think your use of a Keynesian tool (Liquidity Preference) is more accurate? Rothbardian analysis of the supply of money is not dependent on the money multiplier. Furthermore, Rothbard simply shows that the money stock increase as an example towards showing how a rise in prices occurs in his book The Mystery of Banking. The question of how inflation occurs is to look at the accounting process of an increase of the money supply. First and foremost, the amount of paper notes in circulation in accordance to the monetary base effects the rise in price levels. It is absurd to feel that Rothbardians use the money multiplier in a mainstream or orthodox way. Rothbardians take note of the rise in the money stock to acknowledge the future ramifications on prices.

        During the 60s when Operation Twist was first introduced, we noticed that at a later time both long term and short term rates spiked, to the detriment of the economy. Indeed asset-buy backs by the fed will always result in short term rate spikes when the fed ends the process, but it must be noted that ratcheting of Fed intervention has also occurred since the Fed’s first existence. Along with the intervention of the Fed, government intervention through laws, regulations, taxes or false stimulus, can suppress as well as delay the rise in prices and bust period. As is evidenced in viewing the short vs long term rates, they continue to fall. Rothbard demonstrated that in the ERE the yield curve will be flat when there is perfect certainty. In a world where we live, of uncertainty, we are quite aware that entrepreneurs bring about rises and falls in the yield curve when they take on projects not in accordance with the rate of savings. This is counterbalanced by the job of speculators to bring the rate back to par. Yet in our world, even this process is interfered with, since government intervention forces larger rises and falls in the interest rates. Entrepreneurs are deceived even more so than in a free market, not allowing for the efficient weeding out of bad practices and a more accurate way of flattening the yield curve. There is no need to include much more unrealistic nonsense and false models or formulas to this realistic occurrence. Humans are deceived with false rates, especially ones given by fractional reserve banks and their pyramiding processes. Let us not forget the panics which occurred prior to the Fed.

        One must pay close attention to what I just mentioned. Rates are being suppressed, and looking at the money stock, one must not be to hasty in thinking Murphy is wrong. It is not the job of the Austrian to make predictions, but to simply explain what occurs. Perhaps Murphy’s prediction was rash in time, but one must remember the production process, and notice the rise in capital goods prices.
        http://research.stlouisfed.org/fredgraph.png?g=dXO

        Furthermore, let us not forget shadowstats and the explanation given for how the CPI is jargon statistics fed to us by the BLS. Prices are actually higher than what is mis-reported. Hyperinflation is coming, the only thing that can save us from it is further government intervention of some sort. The money has been created, it’s now all about when the rise in consumer prices will hit us.

        • Adrian Gabriel says:

          When I say the only thing that can save us is further government intervention of some sort, what I mean is that the government intervention will delay the necessary bust period. Government is and always will be bad, let us not forget this essential Austrian component.

        • Justin Merrill says:

          Adrian- “Rothbardian analysis of the supply of money is not dependent on the money multiplier.
          …It is absurd to feel that Rothbardians use the money multiplier in a mainstream or orthodox way.”

          Uhm, read pg. 136 of “Mystery of Banking”. He recites the mainstream “money multiplier” to explain fractional reserve banking.

          Rothbard- “The determinants of the money supply under central banking, then, are reserve requirements and total reserves. The Central Bank can determine the amount of the money supply at any time by manipulating and controlling either the reserve requirements and/or the total of commercial bank reserves.”

          Owned.

          • Adrian Gabriel says:

            As I stated, Rothbardian analysis of the money supply is not dependent on the money multiplier. Rothbard’s use of the very basic concept of the money multiplier was to show how it affected the accounting processes of bank balance sheets, it was not intended to describe the effects on aggregate demand as the money multiplier in your mainstream orthodox macro book will teach.

            “Therefore, if open market purchases of assets by the Fed are a factor of increase of reserves by the same amount, the other side of the coin is that open market sales of assets are a factor of decrease.”

            In The Mystery of Banking, Rothbard never described excess reserves, but one must also account for this in the effects on the money supply. This was his point with the money multiplier, “any” increase in the money stock will affect the money supply. These excess reserves will later become required reserves. It is true, in the basic use of the money multiplier that Rothbard describes, an increase in the money stock will affect the supply of money itself.

            “From the point of view of the money supply it doesn’t make any difference ‘what’ asset the Fed buys; the only thing that matters is the Fed’s writing of a check, or someone writing the Fed a check.”

            Of course one must be aware of the change in time preference schedules of individuals to understand how a change in the money stock can affect a change in prices in the long run. It is not liquidity preference that will affect a change in the interest rate, but a change in the time preference schedule of individuals.

            • Justin Merrill says:

              Now you are just talking in circles and trying cover for past false assertions. Rothbard’s use of the money multiplier is exactly the same as is taught in the orthodox view. The money multiplier just asserts that there is a stable and institutionally determined ratio between reserves and bank money. You seem to think that it means something about aggregate demand.

              Here you go again, making statements that are verifiably false.

              “In The Mystery of Banking, Rothbard never described excess reserves, but one must also account for this in the effects on the money supply.”

              In numerous places Rothbard described/discussed excess reserves and reserve ratios. He also said, “Since banks earn their profits by creating new money and
              lending it out, banks will keep fully loaned up unless highly unusual circumstances prevail. Since the origin of the Federal Reserve System, U.S. banks have remained fully loaned up except during the Great Depression of the 1930s, when banks were understandably fearful of bankruptcies crashing around them, and could find few borrowers who could be trusted to remain solvent and repay the loan. In that era, the banks allowed excess reserves to pile up, that is, reserves upon which they did not pyramid loans and deposits by the legally permissible money multiplier.”

              Reserves and reserve requirements are not usually the prime determinants of the money supply. If you believe they are then you should be wondering why we aren’t experiencing very high inflation. If the money base has quadrupled, then shouldn’t the money supply have increased 40x? According to Rothbard’s explanation of money and banking it should have. But that is not an Austrian idea.

              • Adrian Gabriel says:

                Of course the money multiplier is used in mainstream orthdox economics to depict a scenario where the LM curve is affected by the money multiplier. Thus in turn affecting aggregate demand. This was my claim, and something Rothbard does not do at all. What Rothbard does is show how banks create money through asset purchases sitting on the balance sheets of banks in general. His use of the component is not one that adds any further jargon than the basic principles you’d be fed in a mainstream orthodox economics class.

                The subtle explanations of excess reserves were not thorough enough to explain the affects of such reserves on time preferences of individuals. Rothbard in The Mystery of Banking shows how excess reserves do lead to future inflation, take a look at the footnote on page 237, but not in a manner which would describe the effects on time preference schedules of individuals.

                There are various other reasons that the new money being created by the Fed has not yet lead to hyperinflation. As is witnessed, there is a slow but steady rise in the monetary base, which is being held by the banks looking to profit on small amounts of interest in such things as deposit accounts or corporate bonds. Ballooning excess reserves is simply an omen, as Rothbard showed, towards future inflation. Growing excess reserves will make banks think they can garner interest easier through corporate bond purchases, instead of lending quickly. It is indeed fear of lending to untrustoworthy borrowers. At this time, banks and financial institutions would rather sit on the money and earn little interest, than give a big push towards lending to shaky borrowers. The money is being lent, a little at a time, for this reason construction projects have gone up, as have refinances and home mortgages.

                My reference to the money multiplier being a less vital component in Rothbard’s analysis than mainstream analysis, is due to the fact that once the money is made, inflation will ensue. Indeed Mises did say there is no inflation if the money is not lent out, which should be an evident fact in this case. Rothbard never made any predictions as to when there would be hyperinflation, he just delineated the realistic facts that ensue when new money is created. Rothbard also showed its effects on subjective value scales, and how people reacted to such cases where the money stock had been increasing.

                Also, it is true that reserves or reserve requirements are not the prime determinant of the money supply, but they are strong signals toward future ramifications of growing the money stock. It cannot be denied that the rise in excess reserves will turn into required reserves, and as this money slowly leaks into the system, inflation will reach the consumer at the final stage.

                As is evident, capital good prices are rising, and they will keep rising as banks look to make profits and lend more money out when their small amounts of interest bearing deposits is not enough for them. There are various factors keeping banks from lending, and government intervention has a lot to do with it at this time. Yet that intervention is not enough to keep banks from desiring profits like any business desires profits.

                To further explain the lack of such hyperinflation in the system, one should venture towards the shadowstats website to realize the false calculations used by the BLS, to see that prices really are higher. It would also not hurt to take a venture towards capital goods prices

            • Justin Merrill says:

              Now you are talking out of both sides of your mouth when you say, “Also, it is true that reserves or reserve requirements are not the prime determinant of the money supply, but they are strong signals toward future ramifications of growing the money stock.” because you are both citing and contradicting Rothbard.

              Rothbard- “The determinants of the money supply under central banking, then, are reserve requirements and total reserves. The Central Bank can determine the amount of the money supply at any time by manipulating and controlling either the reserve requirements and/or the total of commercial bank reserves.”

              • Adrian Gabriel says:

                This is true Justin, but it is not the prime determinant. It is a huge factor indeed, because as I explained, once the money has been created, it will have an influence on time preference at the point of it being lent out. The money is already created and thus will trickle down to the hands of the consumer:

                “To return to the original change in demand, on the free market a rise in the demand for and price of one product will necessarily be counterbalanced by a fall in the demand for another. The only way in which consumers, especially over a sustained period of time, can increase their demand for all products is if consumer incomes are increasing overall, that is, if consumers have more money in their pockets to spend on all products. But this can happen only if the stock or supply of money available increases; only in that case, with more money in consumer hands, can most or all demand curves rise, can shift upward and to the right, and prices can rise overall.

                To put it another way: a continuing, sustained inflation—that is, a persistent rise in overall prices—can either be the result of a persistent, continuing fall in the supply of most or all goods and services, or of a continuing rise in the supply of money. Since we know that in today’s world the supply of most goods and services rises rather than falls each year, and since we know, also, that the money supply keeps rising substantially every year, then it should be crystal clear that increases in the supply of money, not any sort of problems from the supply side, are the fundamental cause of our chronic and accelerating problem of inflation. Despite the currently fashionable supply-side economists, inflation is a demand-side (more specifically monetary or money supply) rather than a supply-side problem. Prices are continually being pulled up by increases in the quantity of money and hence of the monetary demand for products.”

                Thus we are left with what affects the demand for money, and Rothbard would suggest that time preference would, as well as the most important subjective value scales.

              • Adrian Gabriel says:

                Also, refer back to my earlier comment here: http://consultingbyrpm.com/blog/2012/12/murphy-inflation-smackdown.html#comment-54407

                You missed a lot of points I made in regards to your quibbles.

      • Nikolaj says:

        Ignore demand for money. yes, of course

        Rothbard:

        “Mises agreed with the classical “quantity theory” that an increase in the supply of dollars or gold ounces will lead to a fall in its value or “price” (i.e., a rise in the prices of other goods and services); but he enormously refined this crude approach and integrated it with general economic analysis. For one thing, he showed that this movement is scarcely proportional; an increase in the supply of money will tend to lower its value, but how much it does, or even if it does at all, depends on what happens to the marginal utility of money and hence the demand of the public to keep its money in cash balances”

    • Anonymous says:

      Horwitz: “I think we’re all saying the same thing. In my view, what you were wrong about is underestimating the demand for money/bank reserves. That doesn’t invalidate Austrian models (at least not ones that understand that the demand for money matters for inflation ;) )”

      Yes, for example, the model sketched here by Murray Rothbard:

      “Mises agreed with the classical “quantity theory” that an increase in the supply of dollars or gold ounces will lead to a fall in its value or “price” (i.e., a rise in the prices of other goods and services); but he enormously refined this crude approach and integrated it with general economic analysis. For one thing, he showed that this movement is scarcely proportional; an increase in the supply of money will tend to lower its value, but how much it does, or even if it does at all, depends on what happens to the marginal utility of money and hence the demand of the public to keep its money in cash balances.”

    • Nikolaj says:

      Horwitz:”I think we’re all saying the same thing. In my view, what you were wrong about is underestimating the demand for money/bank reserves. That doesn’t invalidate Austrian models (at least not ones that understand that the demand for money matters for inflation ;) )”

      Yes, for example the model sketched here by Murray Rothbard:

      “Mises agreed with the classical “quantity theory” that an increase in the supply of dollars or gold ounces will lead to a fall in its value or “price” (i.e., a rise in the prices of other goods and services); but he enormously refined this crude approach and integrated it with general economic analysis. For one thing, he showed that this movement is scarcely proportional; an increase in the supply of money will tend to lower its value, but how much it does, or even if it does at all, depends on what happens to the marginal utility of money and hence the demand of the public to keep its money in cash balances”

  4. xgsmmy says:

    About the Delong comment section, Delong pre-screens every comment on his site, which makes it somewhat inefficient for commenters to “talk” with one another, which may help explain the “weirdness” over there.

  5. von Pepe says:

    What if we had counted asset prices in the inflation bet?

    I would love to hear Prof. Henderson’s view of Alchian on this topic since I think Alchian would of been one of Prof. Henderson’s teachers at UCLA.

  6. Yancey Ward says:

    I still think the inflation gets hidden in the rising value and quantity of finanancial assets. When I look at the PTTRX in my 401K, what is it exactly that I own?

  7. Matthew M. says:

    I can’t believe DeLong made such an embarrassing post. Oh wait, maybe he just doesn’t want Bob to be lonely. How nice of you, Brad ;-)

    In addition to the excellent points Bob makes, I must add, what’s up with DeLong’s extreme hyperbole? He writes as if there was 10% deflation.

    Also, the comments in DeLong’s posts are censored. Mine never got through, and it was G-rated.

    • teoc2 says:

      “…what’s up with DeLong’s extreme hyperbole?”

      perhaps DeLong’s understanding that the “Austrian School of Fiction” has much to answer for in the political dynamic that is responsible for the unemployment numbers and the consequences of the those numbers are more poignant for millions of families than the outcome of a $500 bet between economists

      • Yancey Ward says:

        Because, God knows, the Austrians are running things.

        • Richie says:

          They are, and luckily we have heroes like the DeLong and Krugman to save us all.

        • teoc2 says:

          well, as a matter of fact, in the gerrymandered House of Representative and in the super majority reality of the US Senate The Austrian School of fiction has much greater influence than the electorate ever sanctioned

          • Matthew M. says:

            Who in Congress can be reasonably considered Austrian? Only those with a consistent voting record to back up the rhetoric, please.

            I think it’s less than 10.

            • teoc2 says:

              that is one of the beauties of libertarianism and the Austrian school—those considered members of the initiate is a moving target.

              Grover Norquist has an influence over the Congress vastly out of proportion to his electoral authority.

              please note I said the Austrian School of fiction has much greater influence than sanctioned by the electorate—it would appear you’ve made my point

              • Matthew M. says:

                No, sorry, that doesn’t make any sense at all. You’re attributing the influence of non-Austrians to Austrians, and assuming the electorate has been tricked into electing “Austrian influence”.

              • Matt Tanous says:

                Grover Norquist is not and never was a follower of the Austrian school of economic theory. The GOP tends to follow a watered down version of supply-side or Chicagoite thought, depending on the time frame.

              • teoc2 says:

                Matt; Matthew—thank you for making my point…

                that is one of the beauties of libertarianism and the Austrian school—those considered members of the initiate is a moving target.

        • Ferruccio says:

          The Gubernator was (limited to a slice of power in the economically largest State) until retirement (and womanizing-related disgrace)… an Austrian born and bred, Mr S.

          If you’re thinking of the economic theories often called “Austrian”, as opposed to the wonderful country by that name and its denizens, I believe that since Greenspan’s retirement (and subsequent economics-related disgrace, though it appears he can’t shut up anyway) very little sympathy’s left for that “school” in high economics policy circles, Keynes and Friedman being back instead.

          But I see why a commenter calls the Tea Party into play… their economics, as far as they go, do appear to me to be very “Austrian”-influenced. Still, they don’t “run things” at this point, they mostly act as spoilers;-)…

    • Gene Callahan says:

      “Also, the comments in DeLong’s posts are censored.”

      No, they are moderated. Censorship is an entirely different matter.

      • martin says:

        Is it? What’s the difference?

        • Major_Freedom says:

          Whether or not you are partial/apologetic to the censor’s philosophy.

  8. AP Lerner says:

    Coming out of my self imposed ban for one post and one post only.

    The issue here isn’t you made a poor call. It happens. Your point in regards to Romer is spot on. The issue here is your ‘model’ is all wrong, and has been consistently wrong for decades, and is borderline useless for economic forecasting. You’re model is flow inconstant, violates pretty much every rule of double entry accounting (remember when you tried to convince me assets DO NOT equal liabilities + equity…), and is based on a monetary system that has not existed in over 30 years. Yet you refuse to change your thinking. Why. I think that’s called intellectual laziness. Or wedded to a false ideology. Take your pick.

    But, to be fair, you’re not in the business of economic forecasting. You’re in the business of economic indoctrination.

    Go back and look at my comments (actually, I’m sure you don’t have to go back. I’m sure you remember most of them). My batting average over the last two years is pretty close to perfect. Go back and look at Warren Moslers blog, and his posts over the last 10 years. Near perfection. By picking a battle with Delong, you’re picking a battle with the ‘B’ team. Pick a battle with Mosler. Pick a battle with Norman. These are the guys breaking new ground and setting the new standard. But pick your battle honestly. Your prior slanderous critiques were embarrassing

    There is a reason why MMT’ers are managing and making money, and Austrians are struggling with free advice…

    Good luck.

    • Bob Murphy says:

      AP Lerner wrote:

      remember when you tried to convince me assets DO NOT equal liabilities + equity

      Was it the same debate we had over A is A?

    • Richie says:

      Thanks, now go back to banning yourself.

    • Matt Tanous says:

      Assets only equal liabilities + equity when your liabilities are actually covered by your assets. (Equity being, by definition, the value of the assets over the cost of liabilities.) If I promise to loan someone $10K I don’t actually have, but pretend I do, I have a liability of $10K with no assets at all for it.

      “There is a reason why MMT’ers are managing and making money”

      Isn’t that what Austrian follower Peter Schiff does?

      MMT is absolute nonsense – it doesn’t even work logically in theory. Making money on the stock market is not a test of economic sense – millions of people do that without any understanding of economics at all. “Prediction” is garbage in economics – it proves nothing either way.

      • Matt Tanous says:

        Oh, I should note that I consider “negative equity” to be an accounting fiction with no use in economics.

    • Greg says:

      MMT is a joke. Your most prominent follower, Cullen Roche, even says it’s wrong now. Now get back in your statist cave.

    • Greg says:

      Also, I am tired of people like you saying MMTers are “making money” and getting “everything right”. That’s total BS.

      Randall Wray said the USA was in a “depression” in 1994 before one of the biggest booms in economic history.

      http://www.levyinstitute.org/pubs/wp124.pdf

      MMT has also been predicting the collapse of the Eurozone since 1999. You only had to be wrong for 10 years before you were right. And then even in 2010 they predicted the Euro would “collapse”. This was totally wrong.

      http://bilbo.economicoutlook.net/blog/?p=19247

      Mosler said we were in a depression in 2011. GDP was 3.1% last quarter.

      http://moslereconomics.com/2011/03/15/welcome-to-the-7th-us-depression-mr-bond-market/

      Then you have Wray saying commodities were the “biggest bubble of all time” last year.

      http://www.nakedcapitalism.com/2011/09/randy-wray-the-biggest-bubble-of-all-time-%E2%80%93%C2%A0commodities-market-speculation.html

      Then, best of all, you have Mike Norman telling Peter Schiff there was no housing bubble in 2006.

      http://www.youtube.com/watch?v=1G0tfb8ZefA

      Getting everything right? Ha. Yeah, only if you ignore some of the worst calls in economic history.

    • Major_Freedom says:

      MMT is not a prediction model either. If you made good predictions the last two years, it wasn’t because MMT told you so.

      The Austrian model is not “wrong” empirically. It does not make predictions of what people choose to do. It only tells us the logical constraints to all possible outcomes, which enables us to ground economic principles on certain fundamental axioms related to human action.

      Your claim that MMTers are managing and making money while Austrians are not is demonstrably false. There are many managers and money makers who are Austrians. They too only utilize Austrian theory to constrain their range of predictions, not to produce them by formula.

      The Austrian model is not flow inconstant, it does not violate any accounting principles, and is not based on any monetary system, 30 years ago or otherwise. It’s clear you don’t even understand Austrian theory. How surprising.

  9. David R. Henderson says:

    Dear All,
    Here’s my take on my bet with Bob:
    http://econlog.econlib.org/archives/2012/12/my_inflation_be.html

  10. John Carney says:

    Hehre’s my take on Krugman using this to bash Austrian economics.

    http://www.cnbc.com/id/48693368/Krugman_Isn039t_Quite_Right_About_Austrian_Economics

    • Matthew M. says:

      Good article.

      “This situation is not helped by the fact that we can find passages in the work of Ludwig Von Mises, in which rising prices are described as the “inevitable” consequences of monetary expansion”

      All other things being equal, rising prices are indeed the inevitable consequence of increasing the money supply. Problem is, all other things are not equal, which makes predicting tricky, I think a lot of Austrians tend towards excessive pessimism and underestimate the factors that subdue rising prices. The Austrian model is holding up very well, Krugman just takes easy punches at incorrect predictions.

      BTW, I’m surprised we’re letting Krugman get away with this talk of Austrians predicting hyperinflation. Thinking of that Schiff post here, if you actually listen to Schiff, he does not predict hyperinflation.

  11. Mike Sax says:

    “Seriously, how is the above any different from how Keynesians defended Christina Romer, to the point of saying anybody who thought her prediction should be used against her was intellectually dishonest?”

    I think the most intellectuallyhonest criticism of Romer was when Lucas mocked it as “shock economics.”

  12. doug says:

    Kudos, Bob, for getting your own post today on Krugman’s blog.

    As previously a long-time subscriber to the NYT, I recently took out a digital subscription. They report on many things I find interesting, like health. But I intended to avoid Krugman’s blog mostly, for reasons I have avoided the long, discursive tit-for-tat between him and many other economists on the interwebs. I considered the regularly scheduled partisanship and bull crap a poor use of my time. And for the same reason, after initially looking forward to his column when he first started, I avoided it — as probably more often than not, I still do. This, even though one reason for subscribing again was to read the newspaper more, and better identify why and where mainstream economists, and the left, get their ideas about economics so wrong. To give a little background (I virtually never post), I took graduate courses in economic theory from a former student of Paul Samuelson’s, which I enjoyed immensely, as challenging as they were. Of course there was also a certain beauty to it all (mathematically), and an associated certitude about certain things, many or most of which I still consider substantially correct. I only seriously engaged the ideas of Mises and other Austrian economists after graduate school, which I now believe to be more correct, in both theory and from events — and from life or reality more generally.

    There was also this mention today by Nancy Folbre on the Economix Blog in the NYT:

    “Conservatives tend to describe government employees as unproductive, a legacy of the late 19th century Austrian school of economics, popularized by the writer Ayn Rand. . .

    “A good economic system rests on sharing and caring as much as, if not more than, taking and making. Ever wonder why the first part usually gets left out of the story?

    This suggests, considering also the entire context of that post, that she may not know a lot about the subject.

    Admittedly she might, but big differences exist between Rand and Austrians. And many Austrians (probably even of the “19th century” variety) are all for private (or voluntary) sharing. Austrians also recognize the kind of wealth and nefarious activity that inflation and crony capitalism promotes. Probably few Austrians were also big Romney supporters, and if they were, perhaps they viewed him as the lesser of two evils. (I don’t recall a great deal of amity or harmony with Ron Paul at the national convention.) But the way that blog post is written, that isn’t what a casual reader would take away from it.

    It seems to me a lot of things are being conflated there.

    Perhaps Paul Krugman will one day take you up on your offer, and perhaps help narrow and better define the honest differences of opinion for all concerned?

    Or more likely, nah, . . . the base political arguments are more important??

    When I see comments about Republicans or Austrians adhering more to ‘their religion’, it gives the impression to me that the commenter knows little about the methodological criticisms made by Mises and Hayek and others, or that the same might legitimately be said (at a minimum, even why it might be said) from the opposite direction.

    Anyway, kudos again, Bob, for fighting the good fight. And happy new year.

    On Not Learning, Continued
    http://krugman.blogs.nytimes.com/2012/12/31/on-not-learning-continued/#postComment

    Sharers, Takers, Carers, Makers
    http://economix.blogs.nytimes.com/2012/12/31/sharers-takers-carers-makers/?ref=economy

  13. Marc says:

    “Fine, I’ll point to Mish, a super-free-market guy (not sure if he formally embraces Austrian economics per se) who has been calling for deflation since the crisis set in. So why doesn’t the example of Mish (and there are others) rescue free-market critiques of Big Government?”

    Bob, what about Nouriel Roubini’s prediction of the 2008 crash?

    • Bob Murphy says:

      Bob, what about Nouriel Roubini’s prediction of the 2008 crash?

      And what about Noah’s prediction for precipitation?

      Do you guys really not get the very modest point I’m making here?

  14. Bala says:

    “Finally my substantive point: I have never seen any of these guys explain why price inflation (and interest rates) are the decisive criteria for whose model and hence policy recommendations are right.

    I would in fact go one step further and ask why predictive power is the correct measure of the correctness of a theory. I have had this discomfort about your bet all along that you were taking the wrong path by falling for the “I made a better prediction-Hence my theory is better” approach. As true Austrians, we should all desist from making precise predictions on economic phenomena and stick to long-range explanations.

    • Ronkol says:

      If predictions don’t hold, how can a theory be verified? If it can’t be verified it’s not economic science but just ideology based on hopes and faith.

      And in the long run we are all dead.

      • Bala says:

        And what if the subject matter of a study is not amenable to prediction simply because there are no causal constants, like it is in the case of human behaviour? What if the only proper method of understanding is deductive reasoning to identify universal laws and explain phenomena? Is deductive reasoning “hope and faith”? Aren’t you dabbling in scientology?

  15. trrll says:

    As a scientist, this comes across as very odd to me. For a prediction to be a test of a theory, it must be derived from the theory in a logical manner. If a climatologist says, “It looks like rain,” and it doesn’t rain, that does not cast doubt on the theory of global warming, because that is a long-term theory that doesn’t make predictions about day-to-day weather.

    As I understand it, Keynesian economics is an equilibrium theory, not a kinetic theory. An equilibrium theory can make predictions on where things are headed, but it is inherently incapable of making predictions on how rapidly they will get there. So how could any economist’s estimate of how long the recession will last be a test of kinetic theory. On the other hand, a theory (to qualify for the name) must make some testable predictions. From a Bayesian perspective, a prediction is a good test of a theory if the same outcome is not regarded (before the fact) as particularly probable if the theory is not true.

    So it is meaningful that Keynesians predicted in advance that large increases in the money supply would not produce inflation while unemployment is still high, and that both short and long term interest rates would remain low, because (a) Krugman clearly explained, prospectively, how the prediction is derived from the theory. and (b) the outcome was not, before the fact, considered likely in the absence of the theory, as evidenced from public predictions of others, and the willingness of quite a few people to make investment gambles that were clearly predicated on the expectation of a steep rise in interest rates, and even willingness to make actual bets on substantial inflation.

    Clearly, from a practical point of view, predicting the impact of government policy on interest rates and inflation is one of the most important things an economic theory can do, so failing to make the same prediction, derived in a clear way from theory, is a significant failing of Austrian theory. Failure of Austrian theory advocates to acknowledge this does not encourage confidence in their scientific competence.

    • guest says:

      Failure of Austrian theory advocates to acknowledge this does not encourage confidence in their scientific competence.

      Fed Exit Plan May Be Redrawn as Assets Near $3 Trillion
      http://www.bloomberg.com/news/2012-12-07/fed-exit-plan-may-be-redrawn-as-assets-near-3-trillion.html
      2012-12-07 (Dec. 7)

      “There is certainly an issue about unwinding the balance sheet” in a way that “is effective and continues to support the recovery without creating inflation,” St. Louis Fed Bank President James Bullard said in an interview in October.

      The bigger the balance sheet, “the riskier the exit becomes,” Richmond Fed President Jeffrey Lacker said during a Nov. 20 speech in New York. “That is something we need to think carefully about.”

      “They have to find ways of unwinding the balance sheet without dumping all of it in the marketplace,” said Memani, who oversees a bond portfolio of about $70 billion, including about $6 billion of mortgage-backed securities.

      The central bank has been extending the maturities of its assets with Operation Twist, a program to replace $667 billion of short-term debt with the same amount of longer-term bonds that expires this month.

      Stress Tests No Sweat
      http://www.businessinsider.com/stress-tests-no-sweat-2012-5
      Peter Schiff, March 14, 2012

      Despite endorsing phony economic data that shows the US is in recovery, the Fed knows full well that the American economy cannot move forward without its low interest-rate crutches. Ben Bernanke is trying desperately to pretend that he can keep rates low forever, which is why that variable was deliberately left out of the stress tests.

      Unfortunately, rates are kept low with money-printing, and those funds are starting to bubble over into consumer prices. Bernanke acknowledged that the price of oil is rising, but said without justification the he expects the price to subside. This shows that Bernanke either doesn’t know or doesn’t care that the real culprit behind rising oil prices is inflation. McDonald’s, meanwhile, is eliminating items from its increasingly unprofitable Dollar Menu. A dollar apparently can’t even buy you a small order of fries anymore.

      Unless the Fed expects us to live with steadily increasing prices for basic goods and services, it will eventually be forced to allow interest rates to rise. However, if it does so, it will quickly bankrupt the US Treasury, the banking system, and any Americans left with flexible-rate debt.

      That is why the Fed feels it has no choice but to lie about inflation. If it admits inflation exists, then it may be pressured to stop it. However, if it stops the presses, it will bring on the real crash that I have been warning about for the past decade. Just as the Fed’s response to the 2001 crisis led directly to the 2008 crisis, its response to 2008 is leading inevitably to either deep austerity or a currency crisis.

    • Bala says:

      “As a scientist”

      Correct this to “As a scientologist”

  16. Andrew' says:

    The government shockingly manages to create the first deflationary depression in almost a century and the statists crow?

    What a world.

  17. Bill Gross says:

    Yet Krugman goes on to say “But we don’t have to go to hard-liners and marginal figures to find people who refuse to learn.” Ouch. Looks like we’re going to need to raise a lot more money. Surely there are some libertarian millionaires out there…

  18. Brian Macker says:

    Robert Murphy,

    I never thought you understood Austrian theory in the first place. What makes you think that a fractional reserve boom collapse would necessarily always lose out to fiat inflationary money printing? Did Mises or Rothbard ever say that one could predict economic results with any kind of accuracy? Did you forget that Mises talked about having many boom bust cycles before any sort of crack up boom from money printing? What made you decide this cycle was the one?

    I fully expect inflation at some point in the future but not sure if it is this recession or five more from now.

    What were you thinking? I actually was expecting a long period of deflation prior to any inflation kicking in. There was just too much leverage 50:1 for fiat to make any appreciable dent.

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