David R. Henderson  

My Inflation Bet with Bob Murphy

Where Tiebout Goes Wrong... Hail Bob Murphy...

I was going to wait until I officially won my inflation bet with Bob Murphy before announcing it here, but because Brad DeLong and Paul Krugman, each in his own special style, have already announced my win, I'll address it today.

First, here is the bet we made in December 2009:

At any point between now and January 2013, if there is a year/year increase in seasonally adjusted CPI that is at least 10%, then I pay Bob at that time $500.
If we get to January 2013, and there has not been any 12-month stretch in which the above happened, then Bob pays me $500 at that time.

I still have a month to wait before we know who won the bet but all observers, including Bob Murphy himself, think I will win.

Now to the bet itself. Krugman gives it as an example of what he calls an "Austerian" (Murphy) vs., presumably, a "non-Austerian." He never defines his terms but I think he's using the term "Austerian" to combine "Austrian," as in Austrian economics, with "believer in austerity."

That's just strange. First, I do believe in "austerity" if it's defined to mean "big cuts in government spending." Here are two pieces I wrote on it: (1) how well it worked in Canada in the 1990s and early 2000s and (2) how well it worked after World War II in the United States. Krugman seems to refuse to distinguish between big cuts in government spending and big increases in taxes. Both Bob Murphy and I see a huge difference, not just in policy, but also in effects. Second, although I am not, and never have been, an Austrian economist, I am much informed by their thinking, especially the thinking of von Mises, Hayek, and Rothbard. I'm in-between. Fellow economist Jeff Hummel said recently, "When I talk to Austrians, I feel like a neo-classical economist; when I talk to neo-classicals, I feel like an Austrian." That's how I think about myself.

Steve Horwitz, himself a noted Austrian economist, points out:

The most important point here Bob [Murphy] 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).

The kind of thinking Steve displays in his comment was one of the two factors behind my eagerness to bet. The other factor is one I noted a couple of days ago: I've learned over the years not to be excessively pessimistic.

I have the following 3 goals in betting about economics, not necessarily in order of importance: (1) to test my own understanding, (2) to cause the person on the other side to reconsider his beliefs, and (3) to have fun and make money. In this case, I think I've achieved all 3. The one most in doubt is typically (2). But look at what Bob Murphy wrote on his blog today, in response to Steve Horwitz's comment above:

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

That gets at the long-run perspective against excessive pessimism that I noted as one of my motives in making the bet.

Comments and Sharing

CATEGORIES: Monetary Policy

COMMENTS (20 to date)
Bob Murphy writes:

For sure, this has been one of the most fun ways to blow $500 I've ever experienced. Much better than Blackjack.

David R. Henderson writes:

@Bob Murphy,
That's a good point. When I go to Vegas, I spend precisely 0 on gambling. And so to do it on topics I love thinking about makes sense. That's in category (3) above.

nick bradley writes:

Did Canada have an output gap that was >7% of GDP? Was inflation <2%? No.

It's simply absurd to discuss austerity with high unemployment and no inflation.

I'm all for cutting government spending, but I think we should just send the savings back to people in the form or checks. Or tax cuts. As inflation goes up, and unemployment goes down, we reduce the size of the checks

[less-than sign changed to html entity--Econlib Ed.]

David R. Henderson writes:

@nick bradley,
I don't understand your second question. Was inflation what? Please clarify.

Tom West writes:

Was inflation what?

He probably has a less than or greater than sign that was interpreted as an HTML tag. To include such a symbol in one's post use "&lt;" for < and "&gt;" for > (no quotes in either)

E. Barandiaran writes:


Although I have not read anything written by Bob about his bet with you, most likely he made the mistake of assuming that the increase in bank reserves with the Fed since September 2008 (accounted as part of the monetary base) amounted to an increase in the Fed-controlled supply of monetary base. Rather than the base, Bob should had paid attention to currency because the Fed's accountants cannot manipulate its amount (btw, you should read the nonsense post about a shortage of $100 bills for tax evaders written by S. Sumner).

Anyone familiar with the accounting of transactions between a central bank and commercial banks during a financial crisis knows the manipulation of CB's accounts to hide what's going on. In late 2008 and during 2009, I warned Arnold about this problem and how difficult was to verify how the accounting had been done. I'd say that fake-accounting is the tool of moral suasion as discussed in old textbooks on money and banking. And never use data that you cannot verify.

nick bradley writes:


My Comment got turned into an HTML tag.

my point is that with massive unemployment and low inflation, austerity just causes depression.

austerity works Well with full unemployment and high inflation.

I don't think Canada had 8% unemployment and 2% inflation in the mid 1990s.

E. Barandiaran writes:

David and Bob,

Hope you have read these two posts



and thought how they relate to the possibility of high inflation in USA. I don't think Sumner's post make sense but it's funny how he tries to develop a new meme for the crisis, but his dragon should not be confused with Woolley's dragon in the second post.

Nick Rowe has an interesting comment to Woolley's post in which he claims that now he knows what Smaug's death might imply --the Peso Problem. The PP assumes something similar to Bob Higgs's regime uncertainty but in relation to the monetary system (think what happened in my beloved home country in December 2001). Now one may argue that the huge bank reserves accumulated in the Fed poses a Peso Problem --the Fed would have sold his "independency" to the banks that may withdraw suddenly a large part of those reserves because their managers are as crazy as Argentina's politicians or whatever. It's possible but not probable. Anyway Bob should ask for an extension of his bet to 2020 --a good year to look backwards.

Josh Wexler writes:


Has anyone pointed out yet that the implicit odds of the bet were not really even money, but actually favored you in terms of expected value (presuming the real odds were a coin flip)? Mr. Murphy is ponying up $500. Had he won the bet, he would pocketing the same nominal amount of cash- but less actual value due to the higher rates of inflation he would have correctly predicted.

-Josh Wexler
New Orleans

Peter H writes:


Canada had 9% unemployment and 2% inflation (roughly speaking, it moved around a bit) in the mid 1990s when austerity was imposed.

MingoV writes:
I've learned over the years not to be excessively pessimistic.
I thought you made the bet because of pessimism. The Fed created over a trillion dollars, but almost none of it is circulating. That limits inflation now, but allows for whopping inflation when (if) the economy begins to improve.
Justin Rietz writes:

Re: austerity, perhaps I'm being obtuse, but I've never quite understood how government austerity hurts the economy.

As I see it, the government, to pay for its spending, takes money from the private sector, money that would have either gone to consumption or investment spending. So to argue that austerity would cause a recession, wouldn't we have to believe that government spending is more productive than private spending? Or am I missing something?

Nick Bradley writes:

@ Peter H,

Thanks. But there were a lot of other factors involved too in Canada. For one, they slashed interest rates by 5% -- we're already at zero. Second, they had an export-led boom through trade with a country 10x their size, correct?

Ken P writes:

@ Josh Wexler, I like it!

@ MingoV, I agree that much of the money was 'trapped' at financial institutions, particularly thanks to Basel III reserve requirements and various requirements in Dodd-Frank. I'm less convinced that "whopping inflation" will result when the economy improves. Such inflation will be met with the headwinds of increased interest rates and a slowing in the rate of economic expansion.

The "excessive pessimism" perspective is very wise.

Peter H writes:


Re: Interest rates, they moved around quite a bit without one clear trend. There was a 5% drop over the course of 1995-1997. But the rate had risen 5% from 1994 to 1995.

Re: Net Exports, they rose a bit in 1993 and some more in 1999, but were on the whole pretty flat (especially as compared to the mid/late 2000s when they soared from Alberta's oil boom.

N writes:


I believe the argument is that the money spent by government would not otherwise have been spent, at that time, due to FUD.

There appears to be some validity to this, when viewed in isolation, but when viewed in a grander scheme, at is probably fallacious.

Steven Murray writes:
Nick Bradley: my point is that with massive unemployment and low inflation, austerity just causes depression.

austerity works Well with full unemployment and high inflation.

I don't think Canada had 8% unemployment and 2% inflation in the mid 1990s.

Canada's austerity was also done when everybody else wasn't (being forced by Germans/Austerians) into doing austerity at the same time, is that relevant?

E. Barandiaran writes:

David and Bob,

Hope you have read Jim Hamilton's New Year post on monetary policy since mid 2008


I think the key to understanding the low inflation of the past four years is Jim's assessment that "Contrary to popular impression, the Fed has not been "printing money like crazy." Instead, banks have so far been content to end each day holding a huge volume of reserve deposits in their accounts with the Fed, as seen in the graph below of the liability side of the Fed's balance sheet."

Jim fails, however, to explain why banks have so far been content with holding that huge volume of reserves. Those familiar with how the People's Bank of China has been financing its huge accumulation of international assets since 1995, or how Chile's Central Bank financed its huge lending to failed banks and private debtors in the crisis of 1982-83, or how Argentina's Central Bank financed its huge subsidy to banks' private debtors in the second half of 1982, know that those central banks either "borrowed" the funds from the public (China, Chile) or "printed currency like crazy" (Argentina, leading rapidly to hyperinflation).

In addition, Jim fails to assess the implications of those holdings of reserves. If they could be converted into currency on demand, they'd be constraining the Fed's "independence", so the banks would be like Woolley's Smaug and everyone should be worried about its death (Rowe's Peso Problem). Based on over 40 years of experience with financial and fiscal crises, I bet, however, that the reserves accumulated since September 2008 cannot be converted into currency on demand and therefore they should not be accounted as part of the monetary base. Anyway, it's just a bet and we cannot ignore that politicians are jumping over the cliff to nowhere and without a parachute.

Joe Cushing writes:

nick bradley:

"It's simply absurd to discuss austerity with high unemployment and no inflation."

It depends on what kind of austerity. Why would it be absurd to cut government? If we cut the government by 2/3, the economy would come roaring back in 18 months. We would become the most productive and prosperous society in world history.

Onto the topic of the bet:

I would never bet about when a major economic event is going to happen but I would make an if then statement. If the government keeps doing what it's doing with spending, then in the future prices are going to rise (inflation has already happened) to the point of a possible currency collapse. It's impossible to say when though.

E. Barandiaran writes:

David and Bob,

In reply to a reader's question, Jim Hamilton writes

Joshua Wojnilower: The challenge is to make sure that banks continue to want to hold $1.5 trillion in reserves. At the moment, that's easy, because demand is essentially infinitely elastic. But as banks perceive more favorable outside investments, that will change. In principle the Fed should be able to control demand by raising the interest rate paid on reserves, or lower supply by selling assets. But getting the number exactly right might be tricky on a balance of $1.5 T; in the old days, just $1 B in excess reserves was enough to have some effects. It might be particularly tricky if inflation expectations start to pick up at the same time that unemployment is weak and/or concerns about fiscal sustainability or full subscription to Treasury auctions come to the fore. "Challenging" is I believe the correct word to use in talking about making the right decisions in such an environment.

Note that I do not insist that such a situation will arise, only that it could.

Jim does not explain why that demand would be infinitely elastic (when teaching, sometimes I assume a demand to be infinitely elastic although I know that's not possible). Also, he does not realize that if banks were to withdraw their "reserves" the increase in interest rates the Fed would have to pay could be too high (he should ask Domingo Cavallo what happened in late July 1982, when as President of Argentina's Central Bank he triggered a series of hyperinflation outbursts a la Cagan), and that if the Fed had to sell assets their (much?) lower prices would also lead to high interest rates. Jim wants to argue in terms of the old analysis of the monetary base as if bank reserves and currency were close substitutes, but it is not a good approach to explain the Fed's behavior during the crisis.

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