Rather than have a long series of posts discussing the fallout from my (price) inflation bet with David R. Henderson, I decided to do one comprehensive reply to Brad DeLong and Paul Krugman. I had toyed with not even responding, but two things ruled that out: (1) This isn’t a case of two guys challenging me on some academic point; they are publicly impugning my character. (2) My supporters have pledged (as of this writing) more than $81,000 that will go to a food bank in NYC if Krugman ever debates me on business cycle theory.
If I just walk away from this incident, they might worry that Krugman is holding a trump card against me, and their enthusiasm for promoting the debate will wither. So to be clear, I would still love for Dr. Krugman to publicly debate me on Keynesian vs. Austrian business cycle theory, and if he ever did try to bring up this inflation bet, I have lots I can say in reply, as I discuss below. Because this post will be long, I am organizing it into sections.
I. The Pot Calling the Kettle a Pot
It is simply astounding to me that I am being accused of ideological dogmatism and a refusal to see the merits of my opponent’s position by these particular gentlemen. Brad DeLong is notorious for deleting people’s comments on his blog who say things that disagree with him. This is not an urban legend. It’s happened to me, to Mario Rizzo (you know, that bomb-thrower Mario Rizzo), and other people who are being completely courteous and on-topic. DeLong also has a running series where he nominates the “Stupidest Man Alive” (here’s an example), and he routinely mischaracterizes his opponents’ positions in arguments ranging from economics to politics to philosophy–for example, implying someone was a creationist (who in reality was an atheist) but not actually saying so explicitly, proving that DeLong knew exactly what he was doing. (If you really want a fun anecdote, here I explain DeLong’s outrageously selective reading from Herbert Hoover’s memoirs.)
Paul Krugman, for his part, tells us, “Some have asked if there aren’t conservative sites I read regularly. Well, no. I will read anything I’ve been informed about that’s either interesting or revealing; but I don’t know of any economics or politics sites on that side that regularly provide analysis or information I need to take seriously. I know we’re supposed to pretend that both sides always have a point; but the truth is that most of the time they don’t.” Beyond that, Krugman routinely dismisses his critics as idiots or liars who literally don’t understand intro macro, even if they are expressing a stance he himself held within the previous 15 years.
Let us not forget what the former New York Times Ombudsman Dan Okrent had to say about his professional dealings with Dr. Krugman. He said that after some serious haggling, he once got Krugman to “reluctantly” issue a correction on something in one of his columns, and then Okrent comments on that word, “I can’t come up with an adverb sufficient to encompass his general attitude toward substantive criticism.” (I can find people quoting Okrent, but the links to the original seem broken.) But don’t take Okrent’s word for it; just go read Krugman’s blog for a week, and then you tell me if he’s the kind of guy who freely admits when his critics had a good point on something.
So in summary, I am being hauled in front of a tribunal, being accused of dogmatism and an unwillingness to see when my opponents have the better of me…by Brad DeLong and Paul Krugman?! Can this really be happening? I’m hoping Rod Serling can make an appearance and shed some light on these events.
II. Austerian #1 vs. Austerian #2: No Matter Who Loses, Krugman Wins
I made a bet on official CPI and lost. Brad DeLong wants me to announce on my blog, “I have been totally wrong, about everything. I am closing down this weblog for five years to avoid misleading readers while I intellectually retool. You will find me sitting at the feet of Paul Krguman, chanting ‘om mani padme hum’ until I achieve enlightenment.”
But wait a second. I didn’t bet against Paul Krugman, I bet against David R. Henderson. So why wouldn’t I have to sit at David’s feet?
Well, the answer is that David is an “austerian” (in Krugman’s terminology) too. And I don’t just mean if you grabbed him on the street and asked him. I mean, he wrote a study for a DC think tank on how Canada solved its fiscal crisis mostly by actual cuts in federal spending, and he went on John Stossel’s show to preach this message of austerity. That’s the guy who won the bet.
Since David just won a bet, that’s a feather in the cap of his model, and now Brad DeLong has updated his Bayesian priors on David’s worldview, right?
So to summarize, two economists who both have written studies urging fiscal austerity based on the Canadian example (mine here) had a bet. When one of the austerians lost–which had to happen, since ties were impossible–DeLong and Krugman thought this proved austerity doesn’t work.
(In related news, I am trading public trash talking with Chris “Ron Paul’s Freaking Giant” Lawless on Facebook for a game of P-I-G in basketball at a conference in the summer. When one of us loses, will Rudy Giuliani say, “Aha! I was right about 9/11 after all!” ? If so, Chris and I will cancel.)
III. Price Inflation Has Virtually Nothing to Do With Austrian Economics in General, and Truly Has Nothing to Do With Austrian Business Cycle Theory
When explaining why Christina Romer’s notorious unemployment forecasts have no bearing on Keynesian models, but my price inflation forecast blows up Austrian economics, Krugman writes:
[I]t’s really important to distinguish between fundamental predictions of a model and predictions that an economist happens to make that don’t really come from the model….[T]he unfortunate Romer-Bernstein prediction of a fairly rapid bounceback from recession reflected judgements about future private spending that had nothing much to do with Keynesian fundamentals, and therefore sheds no light on whether those fundamentals are correct.
In short, some predictions matter more than others.
Beyond that is the question of how you react if your prediction goes badly wrong.
The fact is that while Keynesians predicting a fast recovery weren’t really relying on their models…
As Alex Padilla quipped on Facebook, if Romer wasn’t using her model to generate the unemployment forecast, then whose model was she using?
But joking aside, we all get the point Krugman is making here, and it’s a valid one. That’s why I’m going to say it applies to my price inflation bet, a lot more than it applies to someone who was saying we needed the Obama stimulus package because it was going to raise employment.
Simply put, my price inflation wager has nothing to do with Austrian business cycle theory. Mario Rizzo spells it out here, and to his credit Daniel Kuehn (who is a huge fan of Krugman and DeLong) also gives this claim a fair hearing on his blog. Yes, I screwed up in my bet with David–and possibly with Bryan, we’ll see–but it’s not because Mises and Hayek doomed me.
Really. For example, I just wrapped up on online course on ABCT and the Great Depression. The only point I recall making about price inflation that was directly tied to ABCT, was that Mises had explained before the Crash why Irving Fisher’s policy of stabilizing consumer prices could still allow an unsustainable boom.
Krugman thinks that worries over price inflation are essential to the Austrian position, because:
The prediction that huge increases in the monetary base will cause large increases in the price level, and that big government deficits will cause big increases in interest rates, are more or less inescapable if your model of the economy is one in which recessions are supply-side problems, not the result of inadequate demand.
Yes, that would be true, if other things were equal. But you could have a big reduction in supply (due to a discoordinated capital structure bequeathed by the preceding boom) accompanied with a big reduction in demand, because the financial world is collapsing and everyone rushes to dollars and Treasuries. This wouldn’t mean that throwing trillions of dollars in new money at the problem would solve the underlying real problem, nor would it mean that modest consumer price hikes would prove that some more $100 bills was the solution.
The fundamental problem here is that Krugman is using a very simple macro model, with a few aggregate variables, and he’s trying to spin out implications of the Austrian view in such a world. Well, that isn’t going to work because the Austrian theory relies on heterogeneous capital goods and the role that artificially low interest rates play in distorting the sectors into which investment flows. You can’t really test to see if that theory is right, by using a model that has AD and AS moving around and causing “the price level” to go up or down.
In any event, Krugman is hardly qualified to be telling us the empirical implications of Austrian theory. In his last written response to me, Krugman asked, “Why is there overwhelming evidence that when central banks decide to slow the economy, the economy does indeed slow?” To be clear, Krugman thought this would embarrass the Austrians, who must not have been aware of the peer-reviewed, cutting edge research showing that when central banks raise interest rates, the boom turns into a bust. This would be like asking a Christian, “Well if God loves us so much, why did He send His son?”
The problem here is that Krugman actually hasn’t read much of Austrian business cycle theory. I’m guessing–can’t prove it–that he read somebody else summarizing it. This is why Krugman apparently classified it as a “real” theory, relying on underlying technological considerations, as opposed to Krugman’s demand-based theory. Since the central bank raising interest rates doesn’t burn crops or kill workers, Krugman thinks the Austrians must not be able to explain how changes in money can affect the business cycle.
Anyway, if you want to see me give a point-by-point response to Krugman’s erroneous understanding of Austrian business cycle theory, read this essay.
IV. “Then Why Did You Bet Bob?!”
Because I thought I would win $500, duh.
Here’s the bigger context: Back in late 2008 and early 2009, many analysts–including me–were freaking out about the unprecedented actions that the Fed and other major central banks were taking. (For example, in June 2009 I explained why I thought the real economy would be “in the toilet for a decade” and that I expected “20+ percent price inflation.”) Bryan Caplan thought we were overreacting, and wanted to bet on something specific, so that the inflation-mongers couldn’t just issue vague warnings that might someday come true. Understanding that he had a point about non-falsifiable hysterics, I bet Bryan $100 in 2009 that by January 2016, official CPI would rise 10% year/year.
Just to be clear–since these two points come up in every comment section on the issue–I was aware at the time that there are serious problems with the way the government calculates CPI, and I knew that if I won the bet, I would be getting paid in weaker dollars than if Bryan won. (I understand that rising prices means a weaker dollar, yes, I do understand that.) Official CPI inflation rose at almost 15% yr/yr at one point in the early 1980s, and since I think what Bernanke has done will ultimately be worse, I am thinking the government won’t be able to get away with reporting less than a double-digit rise.
Seeing my bet with Bryan, David wanted a piece of the action, but he wasn’t comfortable giving such a big window. So he wanted to shorten the horizon from January 2016 down to January 2013, and bump up the amount from $100 to $500. Obviously I was less confident about this bet than the one with Bryan, but I still thought I would win it so I said sure.
V. What Went Wrong?
I’m not sure yet, which is why I haven’t performed seppuku as DeLong insists. I realized that there were a lot of excess reserves when I made the bet with David, but it was also true that M1 had risen strongly since the onset of the crisis (presumably as people fled to very liquid assets). The big thing is that I did not, and do not, trust Bernanke when he tells us there will be a gentle unwinding of the Fed’s balance sheet, and that if things ever started getting out of hand he has all sorts of “exit strategies.” I thought other investors would eventually agree with me that the Fed was simply printing money to buy time and temporarily stave off disaster, and they’d head for the exits. Back in late 2009, I was sure enough that this would happen within two years that I bet $500 on it.
Well, it hasn’t happened yet, so what does that mean? Are we stuck in a dollar and Treasury bubble that is taking longer to pop than I thought? Or have I been “completely, comprehensively, unmistakably, fundamentally, fatally, totally wrong,” as Gentle Brad puts it?
I don’t know, of course, and none of us can, until the bubble bursts or the Fed unwinds its balance sheet with no major hiccups. So I haven’t been writing much on price inflation in a while, and when people ask me in radio interviews etc., I have been prefacing my remarks with, “Let me just admit, I thought this was going to happen already and it hasn’t, so take my analysis with that caveat…”
VI. Learning From My Mistakes, DeLong and Krugman Style
It’s true, Krugman and DeLong have changed their minds on plenty of issues over the years. For example:
(A) Krugman’s notorious 2002 call for Greenspan to replace the bursting tech bubble with a housing bubble. Then, just to be sure there was no misunderstanding, read the 2006 exchange with a reader to see Krugman’s nuanced view of the matter. Having had to explain this extremely unfortunate statement many many times, Krugman has learned to no longer make flippant remarks about the Fed creating an asset bubble to prop up aggregate demand.
(B) In the late 1990s Krugman thought that there was only dubious theoretical justification, and perhaps not a single historical example, for the view that a large fiscal stimulus could rescue an economy from the liquidity trap. Krugman actually used the term “Krugman solution” to refer to a purely monetary approach. Early in the 2008/09 crisis, Krugman championed fiscal policy. Then later, he came back to monetary. In a similar vein, DeLong in early 2009 said monetary policy had “shot its bolt” and was championing fiscal policy. Eventually though he acted like he’d been bosom buddies with Scott Sumner all along.
(C) When it comes to understanding/forecasting the bond markets, Krugman and DeLong have both admitted mistakes. Read what is now a laugh-out-loud funny article from Krugman freaking out about the US government’s debt and the imminent attack from bond vigilantes back in 2003, and in this piece DeLong explains that he has “gotten significant components of the last four years wrong…federal funds rates at zero I expected, but 30-Year US Treasury bonds at a nominal rate of 2.7% I did not.” (HT2 EPJ)
And there are plenty more I could give you. So yes, it’s true: Reading DeLong and Krugman is like watching a ballet, with one dancer named Fiscal and the other Monetary, and at any moment you’re not sure who will be leading the other. But the title of the ballet is, “The Free Market Needs a Genius Like Me to Fix It.”
Krugman and DeLong have tweaked their views over the years, but they are still interventionists. There is literally no empirical outcome that would ever make either of these guys say, “Oh my gosh, I have been totally wrong about the need to prop up Aggregate Demand. I am going to send Peter Schiff an apology.”
So when Krugman says that his Keynesian colleagues have engaged in “soul searching,” this is the kind of thing he means. They’re not questioning the core premises at stake here. Look at how he handled my question about Christina Romer: He didn’t even entertain the possibility that it was the Obama stimulus package that made the economy suddenly “get worse than we realized” in early 2009. No, we all just know that a big deficit creates more jobs than would otherwise be the case, and so if Romer’s forecast was off, well it was because she plugged in the wrong baseline.
In the spirit then of being as flexible and data-driven as DeLong and Krugman, let me report on how much I’ve changed my own views in just the last few years:
(D) I used to think that unemployment benefits and refundable tax credits weren’t that big a deal in explaining the sluggish recovery, but the empirical work of Casey “Poverty Should Have Risen” Mulligan has made me change my mind.
(E) I used to think that if we were going to have a Fed that did something, it might as well lock in a fixed price of gold. But now I’ve been convinced by other Austrians that this would probably be a bad idea, because the Fed officials would just go off the new gold standard the next time it became really onerous, thus discrediting the reform. If we’re going to push for a massive change, might as well go for complete abolition of the Fed.
(F) I used to think–and even wrote it up in my textbook for young readers–that the only way a government debt could impose a burden on future generations, was through the crowding out of physical investment in private capital goods. But then Don Boudreaux and Nick Rowe showed me that government debt can allow the present generation to effectively transfer wealth from their descendants in a much more direct way. Thanks guys, you made the scales fall from my eyes.
(G) Relevant to my inflation bet, I’ve learned something important: The urgent task isn’t to abolish the Fed, but rather to abolish the IRS. Price inflation wasn’t the clear and present danger I thought it was back in 2009. My priorities have altered. First the IRS, then the Fed.
Now that I’ve exhibited the analogous flexibility in my policy views that DeLong and Krugman possess, I’m sure they’ll let me join their League of Distinguished Scientists, don’t you think?
Ha ha, of course not. They get to “change their minds” by tweaking how they want the government to redistribute income and create new money. But when I get something wrong, they want me to drop my drawers, bend over, and ask, “May I have another stimulus, sir?”
VII. Krugman Wins Price Inflation, But Loses a Bunch of Others
Finally, let me remind people of some issues directly related to diagnosing the cause of the recession–”sectoral imbalance” versus “general shortfall in demand”–where Krugman was simply wrong:
(A) In late 2008 Krugman argued that the housing bust had little to do with the recession, because the latest BLS figures showed that unemployment at the state level bore little relationship to the declines in home prices across the states.
However, I pointed out that looking at year-over-year changes in unemployment at the end of 2008 was hardly the right test. If we looked at changes from the moment the housing bubble burst, then five of the six states with the biggest housing declines were also in the list of the six states with the biggest increases in unemployment.
(B) Later, Krugman once again thought he had dealt the readjustment story a crushing blow when he pointed out that manufacturing had lost more jobs than construction. I pointed out that this too wasn’t a valid test, because manufacturing had more workers to begin with. When we looked at percentage declines, then construction did indeed crash more heavily than manufacturing. Furthermore — and just as Austrian theory predicts — the employment decline in durable-goods manufacturing was worse than in nondurable-goods manufacturing, while the decline in the retail sector was lighter than in the other three.
There are other examples–how about Krugman telling people gold went up (as the “inflationistas” would have predicted) not because of Bernanke, but because of Glenn Beck?–but the above two suffice to make my point. I didn’t pick out the above two tests of our theories; Krugman did, and (I argue) he botched the tests. When you run the tests in what is surely a more appropriate way, Krugman’s theory no longer comes out on top, and moreover, his theory can’t really explain the results the way the Austrian explanation easily can.
So feel free to send those links to Dr. Krugman, and let’s see how much soul-searching they provoke.
