## Is the U.S. at Immediate Risk of Rapidly Becoming "Argentina" as a Result of Expansionary Counter-Cyclical Policies?: The Bet with Noah Smith: Noah Bravely Takes the Cochrane-Argentina Side…

The bet:

If, at any time between 7/28/2012 and 7/28/2015, core consumer prices, as recorded in the FRED database series CPILFESL, are up more than 5% in the preceding 12 months, and if over the same 1-year period monthly U3 unemployment (as recorded in FRED database series UNRATE) has not averaged below 6%, then Brad DeLong agrees to buy Noah Smith one dinner at Zachary's Pizza at 1853 Solano Ave. in Berkeley CA, and to pay Noah 49 times the cost--including tax but excluding tip--of Noah's meal at Zachary's in Federal Reserve notes, or in alternative means of payment accepted by Zachary's should Zachary's Pizza no longer be accepting Federal Reserve notes at the date of the dinner. This cost will be assessed as the total cost of the dinner to all, divided by the number of people present, regardless of how much pizza is consumed by or how much alcohol is drunk by specific individuals.

If however, the above condition is not satisfied, Noah agrees to buy Brad one dinner at Zachary's.

Miles Kimball will be the judge in charge of refereeing the bet. The decisions of the judge will be final and unappealable.

Furthermore, Noah's brave and gracious willingness to take the Cochrane-Argentina side of this bet at odds of only 50-1 will not be construed as a statement of his confidence in or of his support for any economist or position of economic analysis that judges expansionary fiscal policy at the zero lower nominal interest rate bound to be "insane" or that judges "1932" to currently be a less dire risk for the U.S. than "Argentina".

The start was my noting that Sebastian Mallaby these days is sounding like a normal reality-based economist--and is far, far from the guy who back in March 2009 thought that what the audience at his CFR conference really needed to hear was the (unrebutted: the panel was stacked) opinions of John Cochrane:

What Do the 1930s Teach About Reforming Today's Financial Markets?: [T]he danger now is inflation.  And I would say it's a greater danger than most of the other people have said.  Our danger now is a run on Treasury debt.  It's not just can the Fed soak this stuff back up again, but can it soak this enormous amount of debt back up again when people don't want either money or Treasury bills or anything labeled "U.S. Government."  The danger is not 1932; the danger is Argentina, a massive run from Treasury debt.  And then monetary policy will not be able to do anything.  You can fool around with interest rates all you want.  When people don't want Treasury bills or money you're stuck….

The system is much more resilient than it was because of deregulation. Back in the Great Depression… if the Bailey Savings and Loan goes under, there is no way that JP Morgan, financed by an equity infusion from the sovereign wealth fund of Kuwait can come in and take over and start lending.  You're just stuck.  Well, we're not in that situation anymore….

Policy is chaotic. Who would invest in this climate?  It's not about toxic assets; it's about who wants to go in on a deal with Darth Vadar [sic], who can change his mind at any moment?  That's the uncertainty that's keeping things from getting going and that's what's slowing the rebuilding of financial markets.  We're facing growth-destroying marginal tax rates, an excuse for the government takeover of large and completely unrelated sectors, class warfare, vindictive ex post taxations….

My great hope is that the bounce-back will be quick before the quack medicine can be said to have worked.  (Chuckles.)  Just as we sort of -- as people think that this insane idea of fiscal stimulus -- which I'll go on with later if I get a chance -- came from Roosevelt's experience with no reason why it should work, there is a danger of thinking all of the crazy stuff they're doing now will have caused the bounce-back….

Cochrane than protested (sounding to my ear much like an old-line Marxist who claims that Marx never said real wages will fall but only that there was a tendency for the real wage to fall) that he had not said that unless the expansionary fiscal and monetary policies of 2009 were reversed the U.S. was about to experience an Argentina-like upward explosion of inflation, but only that there was a risk that, unless the expansionary fiscal and monetary policies of 2009 were reversed, the U.S. was about to experience an Argentina-like upward explosion of inflation.

And Noah Smith said that was a fair point.

I in turn counter-protested to Noah:

There was no reason to think that the expansion of the Fed balance sheet from $700B to$1.7T in mid-2009 would create too-much money chasing too-few goods--for as long as the economy was at the zero nominal interest rate lower bound expanding the Fed's balance sheet simply swapped one very low-yield nominal government liability for another with little effect on anybody's net liquidity or risk exposure. The marginal expansion of the projected national debt from the Recovery Act was absolutely trivial, and since the prospect of future health-care spending deficits had not provoked "Argentina" by 2008 there was no risk the additional marginal borrowing of the Recovery Act would provoke "Argentina" in the context of a depressed economy. Financial markets were not pricing in any chance of an upward explosion of inflation. Cochrane could neither (a) point at elements in the configuration of asset (and other) prices demonstrating that people besides him thought "Argentina" was a substantial risk, or (b) explain the market failure that kept people from hedging against the risk in such a way that we could see their hedges in market prices.

Thus Cochrane's point that he was just pointing out a "risk of Argentina" did not seem to me to be a fair point at all. If it really was a significant risk, than people ought--at the appropriate odds--to be willing to bet that that risk would actually come to pass. So I asked Noah if he was so willing...

Hence we decided on:

• Zachary's pizza because we like pizza.
• A three year term because we are hungry and would like to eat our pizza.
• A twelve-month core CPI change of 5% as our definition of "Argentina"--yes, I realize that that is really absurd and is defining "Argentina" way, way down, but work with us on this…
• An unemployment rate of 6% as marking exit from the depressed-economy régime--the transition from the "involuntary unemployment" to the "inflation" region on the Malinvaud diagram--and entry into a régime in which we would expect inflation to respond in the medium-term to expansionary policies
• 50-1 as the appropriate odds: a 2% chance of the deficits and monetary base expansions of the past four and the next three years triggering the transformation of the U.S. into "Argentina".

I must say that Noah appears to me to not be an expected utility maximizer, or to have a substantially different assessment of the odds than I do: I would have demanded 200-1 to take the Cochrane side of this bet…

Mark your calendars now for August 2015…