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To lower unemployment you need to spend more

I read the headline in the UK Guardian from yesterday (September 15, 2010) – Unemployment claimant count rises unexpectedly which apparently confounded forecasts. The hopes for an export-led recovery as the expectations of the forthcoming public austerity damage private spending plans took a further hammering with the data release showing the “highest balance of trade deficit on record” in Britain and “surveys of the services and construction sectors showing employer sentiment deteriorating sharply”. Why is this surprising? The fact that the so-called analysts and the press are surprised only tells me that they do not understand the way the macroeconomic system works. When there are already severe aggregate demand constraints and the government announces that soon enough they will brutalise public spending what would you expect but a further decline in economic activity? When the rest of the world is easing the fiscal stimulus under the concerted attack by the deficit terrorists why would you expect the balance of payments to dramatically improve? None of this surprises me at all. It is exactly what an understanding of the monetary system would lead one to predict.The reality is that to lower unemployment you need to spend more. There are no surprises in that.

The other salient feature of the UK situation is that underemployment is becoming endemic. The UK Office of National Statistics data for September 2010 showed that part-time employment jumped (now comprising 27.2 per cent of total employment a rise from 25.4 per cent in two years) which suggests that employers wish to maintain as much downside flexibility as they can given their expectations of a double-dip recession are rising by the day.

Conclusion: the new British government are vandalising their economy and lied to the citizens when they said their policy strategy would provide the path out of the malaise they were in. Their strategy is clearly making things worse.

This brings me back to the Trade and Development Report 2010 published by the United Nations Conference of Trade and Development (UNCTAD) which I discussed in yesterday’s blog – Export-led growth strategies will fail.

Today I want to focus on UNCTAD’s analysis of unemployment which begins with Chapter III. In later blogs I will more fully consider their ideas about what governments can actually do.

In 2000, one of the authors of the original NAIRU terminology (Franco Modigliani) showed some contrition when he said:

Unemployment is primarily due to lack of aggregate demand. This is mainly the outcome of erroneous macroeconomic policies… [the decisions of Central Banks] … inspired by an obsessive fear of inflation, … coupled with a benign neglect for unemployment … have resulted in systematically over tight monetary policy decisions, apparently based on an objectionable use of the so-called NAIRU approach. The contractive effects of these policies have been reinforced by common, very tight fiscal policies (emphasis in original

We consider Modigliani’s about face in detail in my recent book with Joan Muysken – Full Employment abandoned.

I particularly liked this section in Chapter III of the UNCTAD Report:

The authorities in the United States may feel more obliged to take countercyclical action to combat unemployment because the welfare system in that country provides much less support than in Europe. But that does not make European welfare systems the cause of high unemployment.

In 2001 to 2003 I did a lot of work on this issue with my Dutch colleague Joan Muysken.

At the time, the influential “macroeconomic consensus” among European researchers as to the cause of unemployment persistence in the European labour markets was characterised by the conclusion that rigidities imposed by labour market institutions and policies dominate all other explanations of the European unemployment crisis of the 1980’s and 1990’s.

This was the central message of the OECD’s Job Study (1994) and later follow-up reports. In the current period, these structural explanations are emerging again as one of the planks that the conservatives are using to attack the use of fiscal policy.

The claim is that the rise in unemployment is actually a structural rise and that aggregate policy (fiscal and monetary policy) cannot reduce it. The argument alleges that structural reforms – that is, deregulation, harsher welfare-to-work rules, cutting of income support – are necessary to resolve the impediments to growth. So push the unemployed closer to starvation and the increased desperation will force them to work.

At the time I wrote a paper – the unemployed cannot search for jobs that are not there – which was subsequently published but you can see a free Working Paper version HERE.

To support the OECD line a host of papers came out from the conservative European and British think-tanks and institutes all purporting to show that these structural variables – like welfare payments and trade union coverage and taxes – were all implicated and driving the unemployment. The policy agenda was clear – free up the labour market and undermine the entitlements and protections that workers had built up over many years of struggle.

We spent a lot of time during those years exploring the econometric models and datasets that the researchers had been using to give authority to the policy conclusions.

Many interesting things emerged. Other than major lapses in econometric technique and convenient use of restrictive samples (that is, shortening or otherwise manipulating the sample of data used in such a way as to bias the estimates towards your own preferred ideological outcome), one stunning result we found related to the veracity of the so-called structural variables that appeared in all these models.

The models effectively deny that aggregate demand matters and that persistently high unemployment is really indicative of a rise in “equilibrium unemployment” driven by structural impediments. So variations in the equilibrium rate of unemployment is allegedly best explained by fluctuations in the tax wedge, the replacement rate, the minimum wage and the user cost of capital.

These are all variables that the government can vary without extra net spending.

But the question we asked – which was ignored by the mainstream literature – was – how structural are the empirical indicators that were being used by this lot in their regression models to show the importance of these impediments?

Using an array of decomposition and spectral analytic statistics tools what we found was that the so-called structural variables (tax wedge, replacement ratio, user cost of capital) were in fact highly cyclical. That is, the business cycle drove significant fluctuations in these variables which explained why they exerted significant influences on the change in the unemployment rates in various nations.

Importantly, once you decomposed (took out) the cyclical component and then ran the OECD-type regressions again to test for the structural effect what do you think happened? Answer: there was no structural effect. All the so-called structural “causation” was being driven by variations in the business cycle and fiscal and monetary policy changes influenced that trajectory in relatively predictable ways (at least in direction – up or down).

So what did that mean? Answer: unemployment is heavily determined by aggregate demand fluctuations which can be managed in a counter-cyclical manner by fiscal policy interventions. Exactly the conclusion that the OECD and all their lackeys had set out to destroy so they could justify the introduction of their neo-liberal supply-side agenda. Pity they didn’t actually establish their results in an honest and/or robust manner.

The literature justified ignoring aggregate demand influences by appealing to the work of Milton Friedman and others who invoke the so-called classical neutrality – that is, in the long-run, real variables cannot be influenced by changes in nominal variables. Which means in English that increased government spending will not increase aggregate demand or employment (in a nutshell!).

This notion had been categorically destroyed of any credibility in the 1930s by the Great Depression and the work of Keynes and others.

The OECD-type studies also always assumed away the fallacy of composition that Keynes and others showed existed when applying classical wage-cutting solutions to unemployment.

Macroeconomics in the 1930s emerged out of the failure of mainstream economics at the time to conceptualise economy-wide problems – in particular, the problem of mass unemployment. Please read my blog – What causes mass unemployment? – for more discussion on this point.

In terms of their solutions to unemployment, they believed that one firm might be able to cut costs by lowering wages for their workforce and because their demand will not be affected they might increase their hiring.

However, they failed to see that if all firms did the same thing, total spending would fall dramatically and employment would also drop. Again, trying to reason the system-wide level on the basis of individual experience generally fails.

Wages are both a cost and an income. The mainstream ignored the income side of the wage deal. The technical issue comes down to the flawed assumption that aggregate supply and aggregate demand relationships are independent. This is a standard assumption of mainstream economics and it is clearly false.

Mass unemployment occurs when there are not enough jobs and hours of work being generated by the economy to fully employ the willing labour force. And the reason lies in there being insufficient aggregate spending of which the net spending by government is one source.

The erroneous mainstream response to the persistent unemployment that has beleaguered most economies for the last three decades is to invoke supply-side measures – wage cutting, stricter activity tests for welfare entitlements, relentless training programs. But this policy approach, which has dominated over the neo-liberal period, and reflects their emphasis on the individual falls foul of the fallacy of composition problem.

They mistake a systemic failure for an individual failure. You cannot search for jobs that are not there. The main reason that the supply-side approach is flawed is because it fails to recognise that unemployment arises when there are not enough jobs created to match the preferences of the willing labour supply.

The research evidence is clear – churning people through training programs divorced from the context of the paid-work environment is a waste of time and resources and demoralises the victims of the process – the unemployed.

The conclusion we came to was that whatever the validity of the theoretical model that relates structural variables to the evolution of the equilibrium unemployment rate, the empirical work that is typically performed to accompany the theoretical development cannot be used as an authority to underpin the theoretical development. In general, the models are mis-specified, contain several untested (and invalid) empirical restrictions which invalidate the resulting inference.

In my recent book with Joan Muysken – Full Employment abandoned – we also provide a thorough critique of the theoretical models that are typically used in this debate. They leave out key variables and rely on very ad hoc assumptions to deliver their theoretical outcomes.

However, all these considerations were largely ignored at the time. Many academic studies sought to establish the empirical veracity of the neoclassical relationship between unemployment and real wages and to evaluate the effectiveness of active labour market program spending. This has been a particularly European and English obsession. There has been a bevy of research material coming out of the OECD itself, the European Central Bank, various national agencies such as the Centraal Planning Bureau in the Netherlands, in addition to academic studies.

The overwhelming conclusion to be drawn from this literature is that there is no conclusion. These various econometric studies, which have constructed their analyses in ways that are most favourable to finding the null that the orthodox line of reasoning (that wage rises destroy jobs) is valid, provide no consensus view as Baker et al (2004) show convincingly.

Further, in the actual real world (outside of the halls of academic research), things starting falling apart for the consensus view about unemployment.

As various governments feverishly implemented the OECD Jobs Study supply-side agenda through the 1990s and simultaneously constrained demand as noted in the quote above by Modigliani by enforcing restrictive fiscal and monetary policy regimes they observed very little improvement in unemployment. By the early 2000s it was clear to anyone who could see beyond their ideological glasses that the policy agenda was a total crock.

Several studies emerged around then that drove the point home. In the last 10 years, partly in response to the reality that active labour market policies have not solved unemployment and have instead created problems of poverty and urban inequality, some notable shifts in perspectives are evident among those who had wholly supported (and motivated) the orthodox approach which was exemplified in the 1994 OECD Jobs Study.

In the face of the mounting criticism and empirical argument, the OECD began to back away from its hard-line Jobs Study position. In the 2004 Employment Outlook, OECD (2004: 81, 165) admitted that “the evidence of the role played by employment protection legislation on aggregate employment and unemployment remains mixed” and that the evidence supporting their Jobs Study view that high real wages cause unemployment “is somewhat fragile.”

The winds of change strengthened in the 2006 OECD Employment Outlook entitled Boosting Jobs and Incomes, which is based on a comprehensive econometric analysis of employment outcomes across 20 OECD countries between 1983 and 2003. The data sample included those who adopted the Jobs Study as a policy template and those who had resisted labour market deregulation. The report provided an assessment of the Jobs Study strategy to that point and revealed significant shifts in the OECD position.

The OECD (2006) found that:

  • There is no significant correlation between unemployment and employment protection legislation;
  • The level of the minimum wage has no significant direct impact on unemployment; and
  • Highly centralised wage bargaining significantly reduces unemployment.

This was not given very much exposure by the press and the policy debate barely picked up on it. But it constituted a serious withdrawal from the previous hard-line position. It means that governments who had relied relied on the previous work of the OECD including the Jobs Study to push through harsh labour market reforms such as the widespread deregulation, retrenched welfare entitlements and attacks on trade unions were now without any real authority.

The OECD retractions make a mockery of the arguments that minimum wage increases will undermine the employment prospects of the least skilled workers.

The OECD (2006) also found that unfair dismissal laws and related employment protection do not impact on the level of unemployment, merely the distribution. In my own work I have consistently pointed this out – in a job-rationed economy, supply-side characteristics will always serve to only shuffle the queue. The most disadvantaged stand at the back of the unemployment queue.

All the punishments (removal of income support), incentives, training and other attacks on those standing in the queue will not alter its length. To reduce the queue you need extra jobs and that requires higher levels of aggregate demand.

This point is dealt with very well in the UNCTAD Report (Chapter III).

They say that all observers now agree that during the period between the early 1990s and 2007 (that is, the growth period between the two major recessions) that:

… labour market outcomes were generally unsatisfactory in this period of accelerated globalization: employment typically grew at much lower rates than output – or in some cases did not grow at all – and the share of wages in national income generally declined in both developed and developing countries.

The growing gap between labour productivity and real wages growth has been one of the hallmark characteristics of the OECD Jobs Study period which really provided a policy framework to implement a neo-liberal anti-worker, anti-welfare recipient agenda.

But the interesting (and sad, given the consequences) aspect is that the success was sowing the seeds of its own destruction.

I have documented this trend and this point in several blogs – for example – The origins of the economic crisis.

If you systematically undermine the purchasing power of the workers by squeezing their command on real output (real wages growth) yet enjoy growing output per worker the question is how does all the stuff get sold and profits realised.

This became especially tricky given that the related agenda over this period was to contract the government contribution to aggregate demand.

As I show in the blog just noted the answer was that the financial sector grew spectacularly and the financial engineers pushed huge amounts of debt onto the workers. Now the capitalist not only got increased profits (and share of real income) by squeezing real wages but also were able to extract additional real income from the workers via the interest payments on the debt.

With inflation falling, it was all advantaging capital.

But at the same time it was unsustainable because the private sector (overall) cannot continuously accumulate debt and spend the funds on consumption and housing.

In this context, UNCTAD note that:

… employment creation and a declining wage share are interdependent, in the sense that if wage growth does not keep pace with productivity growth, the expansion of domestic demand and employment creation will be constrained, and that this constraint can only be lifted temporarily, if at all, by reliance on external demand.

They proceed to debunk the standard mainstream arguments relating to the relationship between real wages and unemployment.

They note that:

Rising and persistent unemployment in many countries has prompted a variety of explanations based on new and old ideas concerning the rigidities and malfunctioning of labour markets and the role of the welfare state in generating such “inflexibilities”. According to neoclassical employment theory, the only explanation for high or rising unemployment is that real wages are too high or are rising too fast because strong labour unions or excessively high legal minimum wages prevent wages from falling sufficiently to absorb an excess supply of labour. This reasoning is based on a microeconomic concept that is transposed to the macroeconomic level.

So refer back to my earlier discussion about fallacies of composition.

UNCTAD say in this regard that if you want to run the mainstream (neoclassical) line then the “supply and demand functions have to be independent of each other” which might hold at the microeconomic level “but is not valid at the macroeconomic level”.

The way they express the compositional fallacy is to note that:

… if the decision of a sufficiently large number of households to buy less bread does not affect the income situation of any of these individual households, the fall in the demand for bread should lower its price and result in new and stable relative prices between bread and other products … [but] … if the income situation of all households depends, directly or indirectly, on the value added that is generated by all producers in an economy, and the latter have to adjust their production downwards in reaction to a fall in household demand, this adjustment itself will feed back into aggregate household income through lower total wage income.

In other words, when you try to cut wages across the board, firms will enjoy lower costs (maybe – depending on what happens to productivity) which is a supply-side benefit. But equally, on the aggregate demand side, workers have lower incomes and so spending falls. There is no reason to believe that the latter effect will be smaller than the former.

Indeed, Keynes and others showed that the standard case is that they two impacts will likely offset each other in typical situations and so there will be no net change in aggregate demand and no improvement in employment overall.

However, if productivity falls (morale problems etc) then the supply boost is not forthcoming and aggregate demand will fall. This will, in turn, lead to a rising pessimism among consumers and investors, of the type we are seeing in the UK at present, and so there will be further contractions in aggregate demand.

You end up with rising unemployment, a race-to-the-bottom with respect to productivity growth, falling standards of living and a thoroughly annoyed working class.

There is nothing by way of consolation that you can say about such a strategy. It is mindlessly destructive.

In terms of the so-called structural explanations of unemployment that I considered before, UNCTAD say:

Although the view that legal employment protection, trade union power and generous unemployment benefit schemes are responsible for higher unemployment has become very widely accepted, it has been shown to be empirically unfounded.

Yes it has been yet it still arises in the public debate. For example, in the US Congress debate about whether the miserly unemployment benefits should be further extended all the mainstream “experts” (who know nothing) are arguing along the standard microeconomic lines – that the benefits are undermining search incentives and prolonging unemployment.

There is no empirical evidence to support any of these mainstream notions.

UNCTAD then provide further analysis to support this proposition. They then turn to what they consider to be the only theoretically and empirically robust explanation of persistent (mass) unemployment.

They say:

Generally, in developed countries employment cycles are very closely associated with output growth cycles: employment growth is typically associated with growth of aggregate demand and output … There is also a strong positive correlation between investment in fixed capital and employment creation in developed countries … Once it is recognized that it is not primarily the relative cost of labour but the pace of output growth that is the key determinant of the level of employment, it follows that investment in real productive capacity and the demand expansion that motivates such investment are the drivers of both income growth and employment creation.

So firms form expectations of future demand (and realised sales) and invest accordingly. Fluctuations in investment drive the business cycle and the components of aggregate demand are interdependent via expectations and employment.

So given consumption is induced by faster growth which in turn responds to public spending and investment is dependent on, among other things, expectations of future revenue, you can quickly see the interdependencies.

It is clear that growth builds on itself. But when private spending is stagnant and expectations are very pessimistic what external force will change that? Why will investors once again assume the risk and start building new capacity?

In some of my earlier work (with Joan Muysken) – for example, here is a working paper you can get for free (subsequently published in the literature) – we developed a model based on the notion that investors facing endemic uncertainty make large irreversible capital outlays, which leads them to be cautious in times of pessimism and to use broad safety margins.

Accordingly, they form expectations of future profitability by considering the current capacity utilisation rate against their normal usage. They will only invest when capacity utilisation, exceeds its normal level. So investment varies with capacity utilisation within bounds and therefore productive capacity grows at rate which is bounded from below and above. The asymmetric investment behaviour thus generates asymmetries in capacity growth because productive capacity only grows when there is a shortage of capacity.

This sort of model stands up very well to empirical scrutiny.

Please read my blogs – How do labour markets react to capacity utilisation changes? and Deficits should be cut in a recession. Not! – for more discussion on this point.

UNCTAD then relate the idea that aggregate spending is important for employment growth back to the distributional issue:

Whether or not aggregate demand rises sufficiently to create net employment depends crucially on the distribution of the gains from productivity growth, which in turn is greatly influenced by policy choices. The policies generally adopted over the past 25 years have sought to keep wages low, and have served to translate productivity gains either into higher capital income or into lower prices. They are based on the assumption that the demand for labour will behave in the same way as the demand for most goods (i.e. the lower the price, the greater the demand). But keeping wages low in order to generate higher profits is self-defeating, because without a stronger purchasing power of wage earners, domestic demand will not rise sufficiently to enable owners of capital to fully employ their capacity and thereby translate the productivity gains into profits. A potentially more successful strategy would be one oriented towards ensuring that the gains from productivity growth also accrue to labour: wages rising in line with productivity growth will cause domestic effective demand to increase and nourish a virtuous cycle of growth, investment, productivity increases and employment over time.

The global economies were able to stall the inevitable by increasingly pushing debt onto the private households to keep consumption spending going. But that was never going to last and it came unstuck because the financial engineers had to extend the margin of indebtedness further out into the income cohorts who were not financially viable.

Once the house of cards starting crashing the non-sustainability of this approach was revealed to all. The problem is that we do not seem to have learned from the mistakes.

Neo-liberalism is still dominating the policy debate and essential reforms have not been considered yet. But a double-dip is heading our way and that might provide some scope to reject the fiscal austerity thesis, to reject the export-led growth thesis, and instead to reconsider the basic relationships at the macroeconomic level.


It is very simple – if you want to reduce unemployment you have to systematically provide more jobs. More jobs require more private and/or public spending. If you cut either, then it will never be a surprise to me that the labour market will deteriorate and vice versa.

That is enough for today!

This Post Has 32 Comments

  1. I’m totally convinced by all your arguments saying that government spending to increase aggregate demand is what the economy needs. However surely the unique selling point of MMT is that such spending should not be matched by taxation eliminating the money accumulating at the top end. It is that side of the MMT equation that only seems to be comprehensible to me if viewed from a beggar thy neighbour perspective. If the world were full of nations that all used ample fiscal stimulus (say paying £200 a week to anyone entering the billybog weekly quiz) and matched all such government spending £ for £ with a percentage tax on net worth, then surely capital and resources would flow to where they created the most earnings and things would work. If one country adopted MMT, that government would pay out the £200 a week per person but would only match 50% of that with a tax on net worth. That country would create asset price inflation which would attract capital and resources that would otherwise have been deployed in its trading partners. Because those resources were chasing asset price inflation rather than earnings it would be malinvestment- a perversion of capitalism. Surely just as all countries being net exporters is a daft concept, so it is a daft concept to think that Reaganomic/MMT budget deficits could benefit the global economy as a whole?

  2. Hmm… Interesting point. How does MMT address asset bubbles. Mainstream economics doesn’t address asset bubbles either, as we are all painfully aware.

    I understand in an MMT system, Banks can only loan against assets and all bank loans eventually net to zero.

    As the net savings should be proportional to economic growth, aggregate asset prices shouldn’t balloon above the rate of growth. That’s assuming the financial geniuses don’t invent new criteria e.g. 200% LVR.

    I believe MMT requires most of the derivatives and highly leveraged financial products to be flushed down the toilet (Hopefully along with the financial innovators). I can’t see how MMT can be worse than mainstream in creating bubbles.

  3. Bill, I re-read those blogs you pointed out (I have to say how much I appreciate the work you put in catering for interested lay people like me) . I’m afraid I still don’t “get” MMT in terms of it being good for the world economy or for anyone other than the most rich and powerful. I feel I perfectly get Reaganomics as a way to loot the world and so in that sense I do “get” MMT if as some on here have said Reaganomics is MMT for the hard nosed.
    I don’t find it at all self evident that it is a either a good thing to “expand overall” or possible to adequately “contract in specific places”. To my mind the case for MMT boils down to the case for “expanding overall”. Surely what matters is whether people have real purchasing ability irrespective of nominal deflation. Surely if there was adequate fiscal policy to optimize productive work and that was matched £ for £ with progressive taxation (eg a percentage tax on net worth or whatever) then there would be no monetary expansion and so no long term asset price inflation. If such a policy was world wide then surely asset prices would realign until they were appropriate for the earning potential/affordability of those assets and we would all be richer terms of real resources. To my mind the only problem arises when such a policy is adopted unilaterally by one country so leading it to suffer loss of resources to a trading partner indulging in asset price inflation.
    On your second point about the capability to “contract in specific places”: I find that extremely dubious. People will always delude themselves that increasing asset prices are due to a forecast of future earning potential. What is more if a country has an asset bubble developing then that will be both strengthening the currency and creating jobs at the same time. That is such an attractive cocktail, it will always be indulged. Of course the allocation of resources will be entirely misplaced and so the global economy as a whole suffers but those suffering are not the ones in a position to do anything about it. When Irish property developers were recruiting builders from Poland to build Irish houses (that still aren’t occupied), they didn’t think that maybe the capital/resources would have been better deployed in say Poland (or Mozambique or whatever). To my mind by definition if there is government spending above taxation then that constitutes an asset price bubble (that is taking an aggregate global view).
    Your suggested blog (for me to re-read) is a perfect example of how economists and governments haven’t a hope of getting a grip once they have let the genie out of the bottle. You state “So we have had many years of zero interest rates in Japan. At times, they experienced shocking real GDP growth while at other times, buttressed by strong fiscal policy they enjoyed reasonable real GDP growth over the same period. But there was no asset price boom resulting.” In striking contrast elsewhere on the web it is viewed as a point of fact that the Japanese glut of zero rate money funded booms around the world via the $1T USD Yen carry trade (eg . ).

  4. Further to my above comment, Japan really shot themselves in the foot with their MMTesque policy. The distant booms they fed made jobs in the US/Ireland/UKetc etc but then the bust came back to hit Japan too.

  5. Stone

    I think it is inaccurate to call japans policies MMTesque. They used aggresive MONETARY policies, had some infrastructure projects and ignored the bond rating agencies but they avoided the necessary level of fiscal policies.

    It was weak tea stimulus. It was a neoliberal stimulus package, therefore it was not even half hearted

  6. Stone:

    I think the disagreement you have lies in your assumption that the quantity theory of money is correct.

    Ideally, the government should avoid causing inflation. This does not have to occur by spending being “matched £ for £ with progressive taxation”, as you suggest. The government actually has a lot of non-inflationary fiscal space as long as there is unemployment. Well-targeted deficit spending, regardless of bond sales, will simply inflate the economy’s productive capacity, not its prices. In other words, it’s basically free money with no downside.

    Of course, once you reach full employment and all your factories are running at 100%, then any monetary expansion is likely to inflate prices. That’s when you stop deficit spending. But at that point everyone’s won!

  7. I’d second Grigory’s point–a well-designed government spending program would, I imagine, assist the process of consumers deleveraging and increase demand for consumption goods. This would, in turn, spur investment in consumption goods industries as demand picked up–I’m not seeing the mechanism where asset price inflation takes place. An asset bubble requires rising prices plus an expectation that prices will continue rising–it’s not clear to me how government spending leads directly to the kind of asset price inflation that would fuel a new bubble in the current environment. The Japan example is a good one–the end of the property bubble blew companies’ balance sheets all to hell and they’ve been extremely debt-averse ever since. The fact that interest rates went to zero had no effect, and I think the idea that it strongly contributed to the global property bubble is dubious–prices were going up for reasons completely independent of Japan. Low interest rates might (might) have offered an additional funding source, but I’d say securitisation on a massive scale played a much stronger role in driving demand.

  8. Greg,

    I think you nailed it for me. If the state reaches a point where growth is no longer desirable e.g. levelling population, declining resource base. Surely MMT has to consider running a balanced budget. I’m not sure I can say it out loud here, but logically there has to be a demographic situation where it is neccessary to run a surplus budget and pull money out of the system.


    I can see the direction you are coming from. It is demonstrated clearly in the current system. Profit motive drives human behaviour. People will game any system for short term trading advantage. How negative this becomes, boils down to how well the system is administrated. How the wider needs of society are balanced with the desires of individuals.

    I am searching for an easy to administer system that is hard to manipulate by the vested parties who have aquired the most wealth and influence. The 80:20 rule usually applies, so I’m looking for ways to contain the self interest of the 20% wealthiest. Humans are selfish and greedy. We can’t change that. We need sentient leaders who will legislate on behalf of wider society.

    No system is foolproof from abuse by the selfish, greedy and corrupt. Let’s try to make it harder for them, instead of patting them on the back and helping them on their way.

    I don’t think the Japanese have been shooting themselves in the foot. It’s the British who have the barrel pointed in the wrong direction.

  9. Dear Andrew Wilkins (at 2010/09/17 at 12:19)

    You said:

    If the state reaches a point where growth is no longer desirable e.g. levelling population, declining resource base. Surely MMT has to consider running a balanced budget. I’m not sure I can say it out loud here, but logically there has to be a demographic situation where it is necessary to run a surplus budget and pull money out of the system.

    I think you are not fully comprehending what a budget deficit is. In a zero growth economy (which may or may not be desirable) you will still need a budget deficit if there is an external deficit and the private domestic sector desires to save overall. The point is that a deficit is a flow. Even for output to remain stationary, there has to be a certain flow of expenditure each period. For economic growth to be maintained that flow of expenditure has to be growing each period.

    Flows of spending have to maintained or the economy will contract.

    I hope that clarifies things for you.

    best wishes

  10. Hi Bill

    I think I get that deficit spending is needed facilitate growth in economic activity.

    I am wondering what happens if the population shrinks dramatically or a country (maybe the world) runs of resources to build goods. Maybe a Bird flu incident keeps the population quarantined for several months. There must be a situation where economic activity actually shrinks.

    I just can’t picture how MMT deficit spending works in such a scenario. I just see an excess of bank notes chasing after a diminishing pool of products and services. I also picture the purchasing value of savings diminishing.

  11. Andrew,

    I’ve never read MMT as all deficit spending all of the time. It does seem to be a common misconception.

  12. Andrew:

    MMT seems to suggest (correct me if I’m wrong Bill!) that budget surpluses are required when inflation is high and employment is full. If inflation is high and there is still unemployment – then that means either funds are mis-allocated, or there’s a supply collapse, or some kind of asset bubble is in the works. I suspect that in the later case, fiscal policy would have to be redirected, not withdrawn.

    I’m fuzzy on the details but I agree – the need for deficits seems to be proportional to population growth. With zero population growth and full employment, deficits would only need to support private saving, and I can’t see the private sector just saving indefinitely forever. Eventually they will want to splash out and buy fast cars and flat-screen TV’s once they feel comfortable – maybe it’s some kind of equilibrium state of maximum desired savings.

  13. Andrew,

    The biggest issue with fiscal policy design is when to withdraw it. Unfortunately politicians tend to get addicted to spending, or more likely trapped by their own rhetoric so that they can’t reduce spending without losing face.

    Deficit spending is only there to finance the non-government sectors desire to save *in aggregate*. That means one section of the population could be saving like mad and one spending. (One of the challenges of macro economics is being able to think what happens ‘in the round’ at population level, and realising that doesn’t stop individuals doing the polar opposite at the micro level).

    If you get any destruction of economic capacity then you have to stop spending so much to control inflation. That generally means putting taxes up to eliminate transactions. It would be an exceptional politician that could explain why taxes have had to go up markedly, or public spending slashed, after a major disaster killing so many people, or an supply side shock such as a lack of oil or electricity.

  14. Neil,

    Thanks, I suppose in an MMT system, political expediency would still result in inflationary episodes just as we have with the current system. I believe a sensible balance of economic growth and inflation could be achieved eventually, as taxation and budget levers are pulled.

    I don’t want to think about politicians running crazy surplus budgets and hyperinflation. Leave that for another day. Bill has probably blogged it already.

  15. Grigory Graborenko: It is not inflation of consumable prices that concerns me- what concerns me is that budget deficits increase the real level of savings/investments/assets. That both destorts the economy (resources stop flowing to where they are of real benefit and instead chase ASSET price inflation) and gives undue power and influence to the most wealthy. I kind of feel that the MMTers are in some kind of cocoon somehow insulated from seeing those malign effects at play in the current economy. Lets face it the “Washington Consensus” is to just do whatever is expedient to maximise the transfer of resources from the poorest to the richest. I feel so much attention is wasted in “debunking” the “theories” of the Washington Consensus. Surely the theories are just meant to be a distracting smokescreen and it is vital not to fall into the trap of being endlessly preoccupied with “debunking” blatant bunk.

  16. “The biggest issue with fiscal policy design is when to withdraw it. Unfortunately politicians tend to get addicted to spending, or more likely trapped by their own rhetoric so that they can’t reduce spending without losing face.”

    This is the same issue with monetary policy as well. We’ve had to tolerate two plus years of mindless mental masturbation about what kind of “credible” exit strategy to use and when.

    I see MMTs prescriptions as setting up fiscal policies so they mostly amount to hands off, self accomodating programs, like the JG. As less and less people are in the JG the spending will contract without any politician needing to withdraw it. Also as private sector contracts there is no need for politicians to announce “stimulus” in the form of a jobs program, unemployed people simply make themselves voluntarily available to the nearest JG office or bureau. The problem in the US now is that very little is automatic and unassailable. Politicians have to tout their pork accumulation cred to their districts, fighting in the middle of the night for whatever favor they can curry, while denying someone else theirs!! They get addicted to the power they have not necessarily to increasing the budget deficit. I think one can argue that just about every district has spending needs and most of what gets labeled “pork” actually provides an income for some middle class people (in addition to layering some thiefs pocket). Our crazy system of making everyone duke it out for “limited” funds is starting to crack, and especially in the US its gotten toxic.

  17. I think there is a failure on here to grasp quite what the “liquidity glut” (the flipside of the government debts) amounts to. It is trillions of USD poised to make speculative attacks. Commentators on here have talked as though the only danger is of billionairs taking it upon themselves to buy lots of TVs and so cause consumer price inflation. Surely people appreciate that for those who have more money than they can possibly consume, money is purely power and some MMT concept of “meeting the desire to save” equates to handing them as much power as you can.

  18. stone:

    I think I understand where you’re coming from – you worry about wealth distribution not just aggregate wealth. Fair enough – this is a problem.

    The solution to rich people accumulating massive amounts of assets is not tight budgets, because that usually hurts the poor the most. If the expenditure is well targeted, ie at the lower income brackets, then it’s supporting their ability to save first and foremost, with a trickle up effect for the rich.

    The main cause of inequality is uneven flows of income between the sectors – right now in the US income is being distributed upwards at crazy rates, and yes, they spend it on risky wall street assets that then inflate and pop. The best way to deal with this is simply a better structured tax system. Get rid of loopholes and up the rates on the higher brackets. After all, during the post war boom, inequality dropped, and the middle class grew and saved, all because of deficits and well designed tax systems.

    MMT says you have to tax – not to get revenue, but to stabilize the currency, and promote the public good. Asset bubbles are in no one’s best interest.

  19. @ Stone: I agree with Grigory. MMT is primarily a scientific theory, focused on describing how modern economies, like that of the UK, the US or Australia work, not a particular policy. The question is whether it is true or false, not good or bad policy.

    The reason why many here are complacent about these supposed bad effects of deficit spending – asset price inflation, speculation, financialization, ponzification, empowering the rich, beggaring thy neighbour through international trade, That it would “enlarge both banks and governments of first world countries at the expense of workers in third world countries. It seems on the face of it to be Reaganomics/neocolonialism but with a job creation scheme fig leaf.” etc. — is because the logical chains between the causes and supposed bad effects are not closely reasoned, and empirically and historically, the evidence tends to be the opposite.

    I think you are a good guy with reasonable aims, which many or most MMTers share, but in short, every time you have said “surely” or “the fact is that”, imho what followed is theoretically and empirically wrong. The cures you propose, budget balancing, a fixed amount of money, no nominal growth, etc would and have caused, not cured, the conditions like financialization and ponzification that you fear, while MMT-inspired policies would cure them. This scientific theory comes up with answers completely opposed to your intuition and arguments. Again, the question is whose theory is true or false.

    For instance look at the USA, New Deal & WWII deficits. There were high marginal tax rates, which I too would support, for redistributing wealth and power, but the matching was very far from $ for $. They had the opposite effects about everything you fear, and contrary to your arguments, promoted everything we both think was good. The fact that deficit hawks and greedy financiers want budget balancing and similar policies, and relentlessly oppose MMT-type policies should give you pause. Why would they fight against their own greedy interest? The Clinton surpluses helped cause the 2000’s bubble economy and aided financialization by forcing leveraging, and these bad effects were predicted by MMTers.

    One of the biggest thing I think you miss is that MMT-recommended policy aims to and would increase real wealth, particularly on the bottom end, often in disproportionate size to the amount of spending, and will flatten the distribution of real and financial wealth. Why should one fear asset price inflation if somewhat more net dollars are chasing proportionately even more real assets? That the aim of economic policy should be that everyone’s real wealth increases – which means including things like health, etc that you mentioned – is pretty much universally assumed.

  20. Some Guy, I really appreciate your response to my admittedly anguished questions about the “expanding overall” aspect of MMT. Bill talks about paradigm shifts and false premises at the heart of existing consensus theories. To me the crucial false premise is to fail to fully grasp that all that matters in monetary wealth is the ratios between how much money various people have. Everyone CAN be richer in terms of loaves of bread by improving the efficiency of the economy but monetary wealth can get disconnected from that. Remember finance only lets the most single minded and ruthless prevail and so that is the direction things slide if we let it. From the view point of an imperialist banking elite all that matters is how wealthy they are RELATIVE to others. It is RELATIVE wealth that gives you financial and political power. Normally what western governments try to do is to increase GDP by asset price inflation. This increases a nation’s purchasing ability RELATIVE to that of countries that have been less adept at doing so (eg African countries). Our ruling banking elite have got to maximize both how wealthy their host countries (ie developed countries) are relative to poor countries but also how wealthy the banks etc are relative to the plebs in the developed countries. With globalization, banks etc are increasingly able to view plebs in developed countries in the same way as they view third world citizens. The banks etc need austerity in the developed world so as to prevent financial power going to the Chinese state. The banks etc now care much more about how wealthy they are relative to the Chinese state than they do about pretty much anything else hence the need for austerity to starve the growing wealth of the Chinese state (if plebs in the west don’t spend then the Chinese sate can not accumulate USD).
    If you say the USA or UK could get more affluent by having asset price inflation then you need to justify what honest source there is for that increased affluence. To my mind there clearly isn’t one- it is simply a neocolonialist exploitation of those people who happen to be in countries that are less adept at fostering asset price inflation. Furthermore asset price inflation whilst sucking resources in from the rest of the world nevertheless actually prevents effective resource allocation and so makes the world poorer in terms of loaves of bread even as it makes it wealthier in USD.
    To me for MMT to make a credible case it needs to say who in the world as a whole would be worse of if £ for £ property taxes were to match government spending.

  21. Further to my above comment, given that RELATIVE monetary wealth is what matters, how can a policy of letting money accumulate at the top end (ie the MMT policy of failing to match £ for £ spending and taxation) not end up (however unwittingly) simply handing more and more power over to the financial elite. I have never heard any MMT justification for letting money accumulate except for the flatly stated desire for “economic growth”. “Economic growth” has to be defined and justified before this has any credibility. As far as I can work out it totally does not amount to a growth in the global “loaves of bread” production or consumption. What it amounts to is a growth in the global purchasing ability for “loaves of bread”. What possible benefit could that be to the global economy? All that really matters is the sufficiently equitable distribution of relative purchasing ability (so as to avoid starvation) and the ability of the world economy to meet required consumption. Neither of those are helped by global “economic growth”.

  22. stone, on a friendly MMT blog I threw out an idea I have not heard of and would be curious to know the opinion of people here as well as Bill. If this idea is as old as this world then I would be curious to get some references.

    The problem of global/any national economy seems to be excessive savings, private sector leverage and income inequality. So I got an idea to solve all of these by abolishing existing taxation in favour of a) taxes, discouraging bad behaviour (alcohol etc.); b) income tax to large extent replaced with savings tax

    The obvious logic behind savings tax is to discourage private sector (both household and corporate) from excessive saving. The structure of savings tax might look pretty much like a typical progressive income tax structure however with the maximum tax rate much closer to 100%. Savings tax can have a grace period (say some years to give private sector time to spend) but then kick-in and increase over time (passed from income). There can also be a minimum non-taxable savings amount or share of income allowing for rainy day savings.

    Obviously the point of savings tax is to punishes outrages savings aka Bill Gates and Microsoft. However, in order to avoid shuffling of money between Gates and Buffet there also can be an expensive transaction tax on capital goods/financial instruments and a very punitive tax on capital gains realized on real assets sold within a given period of time or frequency from purchase.

    So accommodating the desires of free market ideologists against income taxation for those people who have brains to earn millions and billions, this idea should simply force such people to spent a tiny-tiny part of their incredible brain power on making sure they spend their millions and billions and do not cripple the whole economy and might not even engage government into the redistribution business.

  23. Sergei,

    John Maynard Keynes, Economic Possibilities for our Grandchildren.

    There are changes in other spheres too which we must expect to come. When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals. We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues. We shall be able to afford to dare to assess the money-motive at its true value. The love of money as a possession -as distinguished from the love of money as a means to the enjoyments and realities of life -will be recognised for what it is, a somewhatdisgusting morbidity, one of those semicriminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease. All kinds of social customs and economic practices, affecting the distribution of wealth and of economic rewards and penalties, which we now maintain at all costs, however distasteful and unjust they may be in themselves, because they are tremendously useful in promoting the accumulation of capital, we shall then be free, at last, to discard.

    Of course there will still be many people with intense, unsatisfied purposiveness who will blindly pursue wealth-unless they can find some plausible substitute. But the rest of us will no longer be under any obligation to applaud and encourage them. For we shall inquire more curiously than is safe to-day into the true character of this “purposiveness” with which in varying degrees Nature has endowed almost all of us. For purposiveness means that we are more concerned with the remote future results of our actions than with their own quality or their immediate effects on our own environment. The “purposive” man is always trying to secure a spurious and delusive immortality for his acts by pushing his interest in them forward into time. He does not love his cat, but his cat’s kittens; nor, in truth, the kittens, but only the kittens’ kittens, and so on forward forever to the end of cat-dom. For him jam is not jam unless it is a case of jam to-morrow and never jam to-day. Thus by pushing his jam always forward into the future, he strives to secure for his act of boiling it an immortality.

  24. Sergei, I personally would prefer a flat % property tax that would tax real estate, cash and stocks all to the same extent. To me what is needed is for earnings to be the lure that directs capitalism rather than asset prices. To my mind no one would get leverage to build up a major tax burden unless it was to do something useful. Currently there is a catastrophic liquidity glut. That needs to be bled off before the private sector can start working for the common good rather than being distracted into feeding off asset price bubbles. I am very keen on avoiding anything that would make people waste real resources. My fear is that your savings tax proposal would cause the overpaid (eg doctors or whatever) to start splashing the cash on new cars etc and so cause a lot of time and natural resources to be wasted. We had a local example of what seemed to me to be capitalism working at its best. Venture capitalists put £1M a year for nine years into a start up company and at the end of it had a profitable £100M company employing 100 people. For the first seven of those nine years the company was loosing money and not worth a penny. In such a situation a property tax would have meant that the venture capitalists would not have had to pay much tax whilst their money was backing to fledgling company. Personally I think Buffet is also the type of capitalist to be encouraged. He tends to chase earnings rather than asset prices. The fact that he stepped in to prop up Goldman Sachs after the crash seemed to me symptomatic of just how far financialization has gone. Remember Berkshire Hathaway actually keeps 20% cash reserves which is surely the converse of being leveraged.

  25. Sergei, I’m also very keen on tax being very simple and impossible to avoid. To my mind a flat across the board % property tax with a 100% inheritance tax on anything more than say £10K would sort things out fine. The key thing would be for legal ownership of property to be dependent on being able to show that you had paid the tax on it. Getting rid of all the current myriad different types of tax would sweep aside all the waste of the tax avoidance industry.

  26. Some Guy, about your point: “The fact that deficit hawks and greedy financiers want budget balancing and similar policies, and relentlessly oppose MMT-type policies should give you pause. Why would they fight against their own greedy interest? “- I think it is important to point out that “greedy financiers” certainly are not advocating balancing budgets by using a property tax on stocks, real estate and cash to match a maintained level of government spending.

  27. stone, the resource wastage is here with us already and it is not a feat of the rich but much more a feat of the poor who try to pretend that they are rich. Or used to try before this crisis. However the problem is the savings of rich rather than expenditures of the poor

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