I read an article in the Financial Times earlier this week (September 23, 2023) -…
I have spent almost the entire time I have been in academic life – from the time I was a fourth-year student, onto Masters, then PhD and subsequently as an teaching and research academic – studying, writing, publishing, and teaching about the Phillips curve and the link between labour markets and inflation. I have published many articles on how full employment was abandoned and how it can be restored taking care to consider how an economy that approaches high pressure might cope with the increasing nominal demands on real output. I have advanced various policy options to resolve the problem of incompatible nominal demands on such output and provided the pro and con of each. I have published some very detailed papers on those questions and my recent book – Full Employment abandoned – went into all the tedious detail of how inflation occurs and what can be done about it. But, apparently, Modern Monetary Theory (MMT) ignores “the dilemmas posed by Phillips curve analysis” as one of its many alleged sins. I wonder what the hell I have been writing all these years
Further, as well as my work on Phillips curves I also live in a small, open economy which means I have a different experience to say Americans who live in a relatively closed and very large economy. The interactions between the external and domestic sectors are different and sometimes the things Americans say about economics need to be recast when considering what will happen in a small, open economy.
I have published lots of papers on the dynamics of such economies and placed my analysis within what we are now calling Modern Monetary Theory (MMT). But apparently MMT ignores the “dilemmas confronting open economies”.
My other MMT colleagues have equally written lots about inflation. The MMT framework is built around an explicit recognition that inflation is the principle risk posed by government (and non-government spending).
So it is a great surprise to me that we have ignored that issue among other things that I thought we central to the way we reason and the arguments we present.
The most usual usage of the word – Ignore is given by Google:
Many people on the progressive side are now feeling the pinch because they have failed to let go of what is essentially mainstream macroeconomic theory, which means they are part of the problem rather than the solution.
They are beginning to attack Modern Monetary Theory (MMT) because it threatens their security as self-styled progressive gurus – wandering around pretending to present meaningful and distinct alternatives the current orthodoxy when, in fact, it takes less than a few minutes to distill everything they say back into mainstream textbook land. That makes them uncomfortable.
There is a growing claim that there is nothing new about MMT – that everything we write about is “well-understood” or “widely understood and acknowledged”. Further, apparently “everybody knows” and New Keynesians are “fully aware” that the government is not financially constrained.
It is very strange – if all the major features of MMT were so widely shared and understood – how do we explain statements from politicians, central bankers, private executives, lobbyists, media commentators etc etc that appear to not accept or understand the basic MMT claims?
Where in the vast body of macroeconomic literature – mainstream or otherwise – do we see regular acknowledgement that there is no financial constraint, for example?
Why is there mass unemployment if government officials understood all our claims? It would be the ultimate example of venal dysfunctional politics to hold that that everybody knows all this stuff but are deliberately disregarding it – for what?
Why do economists still claim that banks lend out their reserves? Why do they think that an asset swap (liquid for near liquid) engineered by the central bank will provide banks with more funds to lend as if banks wait around for deposits before they make loans?
Why don’t papers on banking indicate that loans create deposits rather than engage in the fiction that it is the other way around?
Why do economists still claim there is a monetary multiplier operating when bank reserves respond to broad monetary movements?
I could pose hundreds of like questions. I am not stupid. But I couldn’t answer any of these questions if the claim that everything MMT has proposed is passe in the extreme.
These sorts of claims then lead to statements that there is “nothing new” about MMT – a sort of put down to suggest we are just a bunch of misguided, politically naive, self-aggrandising intellectual minions.
Please note that MMT does not include the word “new” in its descriptor. Also, if some person out there can find any literature written by one of the major MMT academics or authors where there is a claim that the theoretical structure proposed and integrated by the writers is “new” please let me know. I wouldn’t waste my time by the way.
The descriptor of import is “Modern” which like all descriptors can be interpreted in a number of ways. But the way the MMT literature discusses the economy and integrates components from banking, the national account accounts, a deep understanding of the way bond, currency and labour markets work – is certainly modern.
If you think of the New Keynesian literature it employs all the dated concepts that have constrained the applicability of mainstream economics – and leaves all the essential understandings to be drawn from Keynes out of the analysis. They prefer to present a false version of Keynes based on sticky prices. Please read my blog – Mainstream macroeconomic fads – just a waste of time – for more discussion on this point.
It is clear that MMT writers borrow, absorb, integrate strands of theory dating back to Marx and before. There has never been a denial of that. But there are truly novel aspects of our approach that the vast majority of economists progressive or otherwise – who are slaves of the textbook framework – still do not understand despite the claims that everything is understood.
For example, they still talk of the “government budget restraint” and call on the neo-classical literature of the 1960s (for example, the work of Carl Christ) as the authorities in this regard.
They still think that it is the monetary operations that accompany government spending rather than the spending itself that matter. If we are worried about the inflation risk, which is what the mainstream (and the progressives that use the same framework) focus on, then whether the government sells debt to the private markets, or the central bank or to no-one, is of no consequence to the impact of the spending on inflation.
The mainstream macroeconomic textbooks all have a chapter on fiscal policy (and it is often written in the context of the so-called IS-LM model but not always).
The chapters always introduces the so-called Government Budget Constraint that alleges that governments have to “finance” all spending either through taxation; debt-issuance; or money creation. The framework never acknowledges that government spending is performed in the same way irrespective of the accompanying monetary operations.
The model claims that money creation (borrowing from central bank) is inflationary while the latter (private bond sales) is less so. These conclusions are based on their erroneous claim that “money creation” adds more to aggregate demand than bond sales, because the latter forces up interest rates which crowd out some private spending.
All these claims are without foundation in a fiat monetary system and an understanding of the banking operations that occur when governments spend and issue debt helps to show why.
So what would happen if a sovereign, currency-issuing government (with a flexible exchange rate) ran a budget deficit without issuing debt?
Like all government spending, the Treasury would credit the reserve accounts held by the commercial bank at the central bank. The commercial bank in question would be where the target of the spending had an account. So the commercial bank’s assets rise and its liabilities also increase because a deposit would be made.
The transactions are clear: The commercial bank’s assets rise and its liabilities also increase because a new deposit has been made. Further, the target of the fiscal initiative enjoys increased assets (bank deposit) and net worth (a liability/equity entry on their balance sheet).
Taxation does the opposite and so a deficit (spending greater than taxation) means that reserves increase and private net worth increases.
This means that there are likely to be excess reserves in the “cash system” which then raises issues for the central bank about its liquidity management. The aim of the central bank is to “hit” a target interest rate and so it has to ensure that competitive forces in the interbank market do not compromise that target.
When there are excess reserves there is downward pressure on the overnight interest rate (as banks scurry to seek interest-earning opportunities), the central bank then has to sell government bonds to the banks to soak the excess up and maintain liquidity at a level consistent with the target. Some central banks offer a return on overnight reserves which reduces the need to sell debt as a liquidity management operation.
There is no sense that these debt sales have anything to do with “financing” government net spending. The sales are a monetary operation aimed at interest-rate maintenance. So M1 (deposits in the non-government sector) rise as a result of the deficit without a corresponding increase in liabilities. It is this result that leads to the conclusion that that deficits increase net financial assets in the non-government sector.
What happens when there are bond sales? All that happens is that the bank reserves are reduced by the bond sales but this does not reduce the deposits created by the net spending. So net worth is not altered. What is changed is the composition of the asset portfolio held in the non-government sector.
The only difference between the Treasury “borrowing from the central bank” and issuing debt to the private sector is that the central bank has to use different operations to pursue its policy interest rate target. If it debt is not issued to match the deficit then it has to either pay interest on excess reserves (which most central banks are doing now anyway) or let the target rate fall to zero (the Japan solution).
There is no difference to the impact of the deficits on net worth in the non-government sector.
Mainstream economists would say that by draining the reserves, the central bank has reduced the ability of banks to lend which then, via the money multiplier, expands the money supply.
However, the reality is that:
- Building bank reserves does not increase the ability of the banks to lend.
- The money multiplier process so loved by the mainstream does not describe the way in which banks make loans.
- Inflation is caused by aggregate demand growing faster than real output capacity. The reserve position of the banks is not functionally related with that process.
So the banks are able to create as much credit as they can find credit-worthy customers to hold irrespective of the operations that accompany government net spending.
This doesn’t lead to the conclusion that deficits do not carry an inflation risk. All components of aggregate demand carry an inflation risk if they become excessive, which can only be defined in terms of the relation between spending and productive capacity.
But it is totally fallacious to think that private placement of debt reduces the inflation risk. It does not.
If you can find that body of thought and logic in a mainstream (or non-MMT so-called progressive) literature please let me know. I wouldn’t waste my time though on such a futile search.
That sort of logic and thinking is very “modern” and quite novel in that it is not widely acknowledged or understood. If we polled 500,000 economists on whether selling bonds reduced the expansionary effects of government spending almost every one of them would say yes. That means they do not understand how these monetary operations work. MMT emphatically does and adds that understanding to the knowledge base.
In a telephone interview I gave to the Harvard International Review (published on-line on October 16, 2011) – Debt, Deficits, and Modern Monetary Theory – I said the following:
Particular budget outcomes should never be a policy target. What the government should be targeting is real goals, by which I mean a sustainable growth rate buoyed by full employment.
Why do we want governments? We want them because they can do things that improve our welfare that we can’t do individually. In that context, it becomes clear that public policy should be devoted wholly to making sure that there are enough jobs, that poverty is eliminated, that the public health and public education systems are first class, that people who are less well off are able to become better off, etc.
From a macroeconomic point of view, the spending and tax decisions of government should be such that total spending in the economy is sufficient to produce the level of real output at which firms will employ the available labor force. This is the goal, and the particular budget outcomes must serve this goal.
None of this is to say that budget deficits don’t matter at all. The fundamental point that the original developers of MMT would make-myself or Randall Wray or Warren Mosler- is that the risk of budget deficits is not insolvency but inflation. In saying that, however, we would also stress that inflation is the risk of any kind of overspending, whether investment, consumption, export, or government spending. Any component of aggregate demand could push the economy to that point where we get inflation. Excessive government spending is not always to blame.
In sum, we’re quite categorical that we believe that budget deficits can be excessive and can be deficient as well. Deficits can be too large, just as they can be too small, and the aim of government is to make sure that they’re just right to employ all available productive capacity.
This sort of discussion then leads to the fact that some so-called progressives like the neo-liberal contrivance that central banks are apparently depoliticised and stand as independent entities. Apparently, if governments entered a partnership with its central bank to ensure all government spending was backed by appropriate bank reserve operations (with no debt issued to the private bond markets) this would severely undermine financial stability.
That sort of concern is a heartland phobia of the neo-liberals. No progressive worth their salt would sign up to it.
Please read my blog – Central bank independence – another faux agenda – for more discussion on this point.
Apparently, it is good to have a central bank that can stand up to a government because the latter has a propensity to get drunk and the former has to take the “punchbowl” away.
What the hell does that mean? Does it mean that we want a system where the democratically elected government operating within the legal framework of the nation and is pursuing a mandate can be stopped by an unelected and largely unaccountable set of officials in the central bank? Since when has that been an exemplar of progressive thought?
My view of democracy is that we vote out governments who fail. We don’t want elites (corporate or central banking or otherwise) to exercise their own agendas. They were not elected. They are not accountable in the way we construct that term in political life.
But, in fact, the “independence” is a chimera anyway. Treasuries and the central bank have to work together on a daily basis to ensure that the cash system is coherent and no financial instability occurs.
Please read my blog – The consolidated government – treasury and central bank– for more discussion on this point.
Further, it is not an act of political naivety or an act of “dismissiveness of these political economy considerations” to recommend that that we make the central banks more accountable and work more closely with treasury to deal the private bond markets out of the equation.
Clearly, the elites have created a system that works for them. That is what elites do. To then say that progressives are naive for suggesting an alternative is the ultimate wimp out. That is, after all, what a progressive position is – to challenge the orthodoxy whatever it is if there is evidence that the status quo undermines the aims of progressive society.
In the current setting – the way governments operate – both arms (bank and treasury) – is clearly undermining reasonable progressive goals. There has to be a change. Are we just going to lie down and say – well the political economy is stacked up against us so we better have another pina colada and chill out – and not be so naive as to suggest that politics by its very nature is a moving feast and paradigm changes (and even smaller) changes occur with regular historical frequency.
And then we get back to inflation.
Apparently there is no “formal modelling” to explain our ideas. Did Marx, Keynes, and many other great economists use the sort of trivial formality that pervades neo-classical approaches. No? Does that mean these economists or thinkers have “failed woefully”? I doubt it.
I remind readers of the lovely observation by American (Marxist) economist Paul Sweezy who wrote in the 1972 – Monthly Review Press – article entitled Towards a Critique of Economics that orthodoxy (mainstream) economics:
… remained within the same fundamental limits … of the C19th century free market economist … they had … therefore tended … to yield diminishing returns. It has concerned itself with smaller and decreasingly significant questions … To compensate for this trivialisation of content, it has paid increasing attention to elaborating and refining its techniques. The consequence is that today we often find a truly stupefying gap between the questions posed and the techniques employed to answer them.
Mathematics is just a language – one of many. Sometimes it helps to sort out problems that other languages cannot solve. Usually that is not the case, especially is a social science like economics.
Further, the mathematics deployed relentlessly by mainstream economics to hide the lack of substance (the “trivialisation of content”) is second-rate anyway and laughed at by the professional mathematicians. We could write a lot about that.
The sensible principle is to use more accessible language when that is adequate to convey the idea. Some formalism is useful and we have certainly deployed it at times.
But evidently our macroeconomic framework is distilled to a Keynesian expenditure system where the government can use expansionary fiscal policy to “push the economy to full employment” but after that “taxes … must be raised to ensure a balanced budget” is created.
Apparently this “balanced budget condition must be satisfied in order to maintain the value of fiat money”. I wondered where that fiction came from. I might not have read everything my MMT colleagues have published but I know most of it and I know, in detail, everything I have written.
It is plain wrong to think that at full employment the government has to run a balanced budget to ensure there is no inflation.
The non-inflationary condition is that nominal aggregate demand has to be consistent with the real capacity to produce goods and services. What the sectoral balances might be at the point where there is full employment is contingent on many things and the government’s discretionary capacity to ensure all balances equalled zero at that point is next to zero.
It would be an extraordinary coincidence if that was the conjunction of outcomes. My understanding of the historical time series for many nations is that that conjunction has never occurred.
MMT doesn’t say anything of the sort. It is clear that the government budget balance at full employment will be determined largely by the non-government budget balance. The government position might net to a large, small, zero, small negative, large negative surplus.
There is no condition in the MMT literature for a balanced budget at full employment. The responsible policy position would be to reduce net spending at full employment if nominal demand exceeded the capacity to respond in real terms.
We don’t need a few mathematical squiggles to make that point. The lack of formalism doesn’t lead to any misunderstandings or ambiguities in terms of that point.
Any stability analysis that flows from erroneously concluding that there is some balanced budget constraint on the full employment solution is equally nonsensical and has no application.
Finally (I am running out of time), apparently, “MMT lacks an explicit theory of inflation” and more.
That is news to me. What the hell have I been doing for the last three decades?
What were all those articles and a few books I had written that I thought were about inflation, bargaining conflict, the battle of mark-ups, imported inflation via resource prices; incomes policy and indexation, and the Phillips curve and related articles – some with mathematics, many with the latest econometric modelling – actually about?
Apparently, MMT is based on “an L-shaped aggregate supply (AS) schedule” such as that below (which will appear as the first simple model in the MMT textbook I am writing with Randy Wray):
Sure enough if we assume that the price mark-up that firms use to price their goods and services and money wage rates and labour productivity (and all other unit resource costs) then it reasonable to assume that firms would supply output at a constant price – quoted in their catalogues and honour those prices for some time.
There is a cost to a firm of changing prices regularly and also a possible loss of customer loyalty.
On the horizontal portion of the supply curve, firms in aggregate will supply as much real output (goods and services) as is demanded at the current price level set according to the mark-up rule described above.
The vertical portion of the curve after full employment (Y*) is explained by the fact that the economy exhausts its capacity to expand short-run output due to shortages of labour and capital equipment. At that point, firms will be trying to outbid each other for the already fully employed labour resources and in doing so would drive money wages up.
Under normal circumstances, economy rarely approach the output level (Y*, which means that for normally encountered utilisation rates the economy typically faces constant costs.
The description of the model in the textbook acknowledged that
- If the money wage rate rises, other things equal, the unit cost level rises and the firms would translate this into a price rise via the constant mark-up.
- If there is growth in labour productivity (LP) as a result of say, increased labour force morale, increased skill levels, more technologically-based production techniques, better management, and the like, then unit costs (W/LP) will fall. This means that the firms can generate the same profit margin at lower prices. The AS function would thus shift downwards by the extent of the decline in unit costs.
- Variations in the mark-up (m) will cause the price level to change. Increases in industrial concentration, more advertising etc may lead to firms being able to increase the overall profit margin that can be sustained. Tight conditions in the goods and services market, where sales are constrained, may lead firms to reduce the mark-up desired as they all struggle for market share. This could occur as a result of flagging sales and strong trade unions pushing (successfully) for wage increases. Thus to avoid losing market share, the firms may choose to absorb some of the cost rises into the margin.
- If employment is below full employment and thus Yactual < Y*, which means there is an output gap present, then increases in aggregate demand (spending) which are seen by firms to be permanent will result in an expansion of output without any price increases occurring. If the firms are unsure of the durability of the demand expansion they may resist hiring new workers and utilise increased overtime instead. That is, they initially respond to the increased aggregate spending by increasing hours of work rather than persons employed. The higher costs (as labour productivity falls) are likely to be absorbed in the profit margin because firms desire to maintain their market share overall.
There are thus a lot of behavioural factors to be considered and analysed in each specific situation. MMT incorporates these complications in its approach to inflation. It acknowledges that bargaining is central to the wage-price bargains but also allows for industrial concentration, regulation etc to influence outcomes. We have incorporated a lot of institutional literature into our approach.
After considering all that, the draft of our text explicitly states, that:
There is some debate about when the rising costs might be encountered given that all firms are unlikely to hit full capacity simultaneously. The reverse-L shape simplifies the analysis somewhat by assuming that the capacity constraint is reached by all firms at the same time. In reality, bottlenecks in production are likely to occur in some sectors before others and so cost pressures will begin to mount before the overall full capacity output is reached.
This could be captured in Figure 9.5 by some curvature near Y*, thus eliminating the right-angle. We consider this issue in more detail in Chapter 11 Inflation and Unemployment.
That sounds like an explicit statement that there is more to our approach than the reverse-L supply curve. So surely a critic would then abandon the reverse-L claim and head for our work where we discuss unemployment and inflation (the Phillips curve) etc.
Saying things like the reverse-L is “not the way the macro economy works” is not a critique of MMT. We know that. The point is that the reverse-L is the first simple step into a macroeconomics that is not based on perfectly competitive pricing and the supply curves that arise logically from those assumptions.
We recognise (following, for example, Kalecki) that firms price firms on mark-ups and do not vary prices with variations in demand in the short-run. The reverse-L is a de-conditioning heuristic to steer students away from the continuously upward sloping supply models they get in neo-classical text books.
It is not a very difficult research task to find an extensive body of Phillips curve literature published by the MMT authors. I am known as one of the Australian economists who have consistently estimated Phillips curves in Australia over the course of my career. It is a recognised fact.
That literature also includes seminal contributions to the literature on hysteresis that challenges the vertical, non-trade-off world of the natural rate theories and allows for a non-vertical Phillips curve even if price expectations are accurate and fully adjust. I saw no mention of that literature in the recent MMT attacks.
Why not? Clearly it would make the claim that MMT “offers a false choice of unemployment versus full employment with price stability”, when, in fact, we do not offer anything of the sort, unless a major institutional change is made to render the Phillips curve dynamics irrelevant.
That change is the Job Guarantee. I note that in the recent MMT attack the discussion of the Job Guarantee and the discussion of inflation were separate and unrelated. Why? Any reasonable understanding of our approach to buffer stocks will lead a person to realise that the employment buffer approach is not a job creation program per se.
Rather it is a macroeconomic stability framework. It is a way of interrupting the dynamics that underpin the Phillips curve. If the government buys off the bottom – that is, pays the minimum price for a resource that has no bid in the private market (because there is no demand for the labour) then it cannot, in itself, add to cost pressures in the economy.
I have written extensively about that.
The Job Guarantee policy is an example of storage for use where a buffer stock wage is set below the private market wage structure, unless strategic policy in addition to the meagre elimination of the surplus of unused labour is being pursued. For example, the government may wish to combine the Job Guarantee policy with an industry policy designed to raise productivity. In that sense, it may buy surplus labour at a wage above the current private market minimum.
In the first instance, the basic Job Guarantee model with a wage floor below the private wage structure shows how full employment and price stability can be attained. While this is an eminently better outcome in terms resource use and social equity, it is just the beginning of the matter.
There are three options available to an economy, which desires price stability. First, to use unemployment as a tool to suppress price pressures as in the NAIRU approach. Second, introduce the Job Guarantee policy and use the Buffer Employment Ratio (BER) to control inflation. Third, introduce the Job Guarantee policy and augment it with an incomes policy.
Critics of the Job Guarantee approach argue that the rising budget deficits implied would be inflationary, as the NAIRU constraint would be violated. We have considered that issue many times. The nub of our argument is as follows. This is taken from my PhD.
The OECD experience of the 1990s shows that high and prolonged unemployment will eventually result in low inflation. Unemployment can temporarily balance the conflicting demands of labour and capital by disciplining the aspirations of labour so that they are compatible with the profitability requirements of capital.
Similarly, low product market demand, the analogue of high unemployment suppresses the ability of firms to pass on prices to protect real margins. The lull in the wage-price spiral could be termed a macroequilibrium state in the sense that inflation is stable.
The implied unemployment rate under this concept of inflation is termed the macroequilibrium unemployment rate (MRU) – a term I coinded in 1987 (as part of my Phd and early published work).
I noted the concept of the MRU has no connotations of voluntary maximising individual behaviour, which underpins the NAIRU concept.
As a result of the labour market changes, which accompany the business cycle, the MRU is considered to be cyclically sensitive and rises with the actual rate of unemployment. In other words, aggregate demand changes can influence the long-run steady-state unemployment rate subject to capacity constraints.
Clearly there is a minimum irreducible unemployment rate that is equal to frictional unemployment. Steady-state rates above that are subject to change as the level of activity varies. A second article I wrote in 1987 analysed this issue in detail with some formality.
Wage demands in the private sector are thus inversely related to the actual number of unemployed who are substitutes for those currently employed. When the economy slows, many workers lose their skills through obsolescence and new entrants are denied relevant skills.
Structural imbalance, which refers to the inability of the actual unemployed to constitute an effective excess supply, rises in the downturn.
Increasing the structural imbalance thus drives a wedge between effective and actual excess supply. The effective excess supply is the threat component of unemployment. To some degree, this insulates the wage demands from the cycle. The more rapid the cyclical adjustment, the higher is the unemployment rate associated with price stability.
Stimulating jobs growth decreases the wedge because the unemployed develop new and relevant work skills. These upgrading effects provide an opportunity for real growth to occur as the MRU declines.
Why will firms employ those without skills? An important reason is that hiring standards drop as the upturn begins. Rather than disturb wage structures, firm offer training with entry-level jobs. While the increased training opportunities increase the threat to those who were insulated in the recession, this is offset to some degree by the reduced probability of becoming unemployed.
The fact that at some stable inflation rate we can associate an unemployment rate and that it is increases in the latter which ensure the former does not provide a theory of why there are income distribution conflicts between powerful groups in the economy. We might also call this unemployment rate the NAIRU but in doing so we add nothing to the understanding of the inflation process.
It is clear that different theoretical underpinnings can be given to the observation and each theoretical structure brings with it an entirely different comprehension of the role of the NAIRU and what it implies for activist government agendas designed to provide full employment.
Suppose we characterize an economy with two labor markets: A (primary) and B (secondary) broadly corresponding to the dual labor market depictions. Prices are set according to markups on unit costs in each sector.
Wage setting in A is contractual and responds in an inverse and lagged fashion to relative wage growth (A/B) and to the wait unemployment level (displaced Sector A workers who think they will be reemployed soon in Sector A). A government stimulus to this economy increases output and employment in both sectors immediately.
Wages are relatively flexible upwards in Sector B and respond immediately. The compression of the A/B relativity stimulates wage growth in Sector A after a time. Wait unemployment falls due to the rising employment in A but also rises due to the increased probability of getting a job in A. The net effect is unclear. The total unemployment rate falls after participation effects are absorbed.
We could write equations out for all this – and I have. But it wouldn’t give us any greater insights.
The wage growth in both sectors may force firms to increase prices, although this will be attenuated somewhat by rising productivity as utilization increases. A combination of wage-wage, and wage-price mechanisms in a soft product market can then drive inflation. This is a Phillips curve world. To stop inflation, the government has to repress demand.
The higher unemployment brings the real income expectations of workers and firms into line with the available real income and the inflation stabilizes – a typical NAIRU story.
Introducing the Job Guarantee policy into the depressed economy puts pressure on Sector B employers to restructure their jobs in order to maintain a workforce. The Job Guarantee wage sets a floor in the economy’s cost structure for given productivity levels. The dynamics of the economy change significantly.
The elimination of all but wait unemployment in Sector A and frictional unemployment does not distort the relative wage structure so that the wage-wage pressures that were prominent previously are now reduced.
But the rising demand softens the product market, and demand for labor rises in Sector A. There are no new problems faced by employers who wish to hire labor to meet the higher sales levels. They must pay the going rate, which is still preferable, to appropriately skilled workers, than the JG wage level.
The rising demand per se does not invoke inflationary pressures as firms increase capacity utilization to meet the higher sales volumes.
What about the behaviour of workers in Sector A?
The American economist Wendell Gordon (1997: 833) said:
If there is a job guarantee program, the employees can simply quit an obnoxious employer with assurance that they can find alternative employment.
This is a long-standing claim.
With the JG policy, wage bargaining is freed from the general threat of unemployment. However, it is unclear whether this freedom will lead to higher wage demands than otherwise.
In professional occupational markets, it is likely that some wait unemployment will remain. Skilled workers who are laid off are likely to receive payouts that forestall their need to get immediate work. They have a disincentive to immediately take a Job Guarantee job, which is a low-wage and possibly stigmatized option. Wait unemployment disciplines wage demands in Sector A.
However, the demand pressures may eventually exhaust this stock, and wage-price pressures may develop.
At first blush, it might appear that the BER would have to be greater than the NAIRU for an equivalent amount of inflation control. This is because the JG workers will have higher incomes and so a switch to this policy would see demand levels higher than under a NAIRU world.
But the Job Guarantee provides better inflation proofing than a NAIRU approach because the Job Guarantee workers represent a more credible threat to the current private sector employees. In other words, the Job Guarantee pool is a more effective excess supply of labour.
The buffer stock employees are more attractive than when they were unemployed, not the least because they will have basic work skills, like punctuality, intact.
This reduces the hiring costs for firms in tight labor markets who previously would have lowered hiring standards and provided on-the-job training.
They can thus pay higher wages to attract workers or accept the lower costs that would ease the wage-price pressures. The JG policy thus reduces the “hysteretic inertia” embodied in the long-term unemployed and allows for a smoother private sector expansion because growth bottlenecks are reduced.
A further source of cost pressure comes via the exchange rate for small trading economies like Australia. Under a fixed exchange rate regime, unless there is a coordinated fiscal policy among countries it would be difficult for a small open economy to pursue its own full employment strategy.
With higher spending on imports arising from the domestic expansion, the stimulus spreads throughout the fixed exchange rate bloc and the small country would face a borrowing crisis that would negate its full employment ambitions.
It is easy to see that a Job Guarantee model requires a flexible exchange rate to be effective. We can identify two external effects. First, given the higher disposable incomes that the Job Guarantee workers would have compared to if they were unemployed imports would likely rise.
With a flexible exchange rate, the increase in imports would promote depreciation in the exchange rate. We should expect the current account to improve and net exports increase their contribution to local employment. The result depends on the estimates of the export and import price elasticities. The body of evidence available suggests that import elasticities are small (around -0.5).
We interpret this as saying that following depreciation, import spending will actually rise because while we are importing less goods and services we are paying disproportionately more for them. The improvement in the current account thus depends on the estimate of the export elasticity. In Australia, for example, these seem to high.
The direct control to allow the depreciation to be insulated from the wage-price system could be an incomes policy. If the increased spending led to depreciation, through rising imports, a comprehensive incomes policy would be required to reduce inflationary pressures.
Workers and firms would have to agree to allow real the depreciation to stick, as part of the return to the collective will. For everyone to have jobs those who are currently employed would have to sacrifice some real income to permit other to increase their claim on it. The scheme itself would not force up labour costs
The Job Guarantee wage provides a floor that prevents serious deflation from occurring and defines the private sector wage structure. However, if the private labor market is tight, the non-buffer stock wage will rise relative to the Job Guarantee wage, and the buffer stock pool drains. The smaller this pool, the less influence the Job Guarantee wage has on wage patterning.
Unless the government stifles demand, the economy will then enter an inflationary episode, depending on the behavior of labor and capital in the bargaining environment.
In the face of wage-price pressures, the Job Guarantee approach maintains inflation control by choking aggregate demand and inducing slack in the non-buffer stock sector. The slack does not reveal itself as unemployment, and in that sense the Job Guarantee may be referred to as a “loose” full employment.
This leads to the definition of a new concept, the Non-Accelerating Inflation Buffer Employment Ratio (NAIBER), which, in the buffer stock economy, replaces the NAIRU/MRU as an inflation control mechanism. The Buffer Employment Ratio (BER) is the ratio of Job Guarantee to total employment.
As the BER rises, due to an increase in interest rates and/or a fiscal tightening, resources are transferred from the inflating non-buffer stock sector into the buffer stock sector at the fixed buffer stock wage.
This is the vehicle for inflation discipline. The disciplinary role of the NAIRU, which forces the inflation adjustment onto the unemployed, is replaced by the compositional shift in sectoral employment, with the major costs of unemployment being avoided. That is a major advantage of the Job Guarantee approach.
The only requirement is that the buffer stock wage be a floor and that the rate of growth in buffer stock wages be equal or less than the private sector wages growth.
While the conflict theory of inflation is well-established, tying it into the concept of buffer stocks was a unique contribution of the MMT literature.
No person in their right mind would claim that MMT ignores inflation and has no theoretical conception of it.
In a most recent attack on MMT, which stirred a lot of people it seems and led to my in-box being substantially boosted over the last week, I couldn’t find any reference to my own work. I am not miffed that someone chooses not to cite my publications.
But one of the first principles you discuss with doctoral students is the need to capture all the major contributions (articles, books) in a field of study. It is not good enough to selectively ignore – that is, refuse to take notice of or acknowledge”, “intentionally disregard”, “fail to consider” – some of the major works in a field including my own. I not seeking admiration or recognition here – just stating a fact.
If a doctoral student produces a thesis which does ignore major contributions in the field they are researching the result is simple – they fail.
If a professional economist produces material that does the same thing the conclusion is simple – the work is not honest or acceptable, no matter what it says.
Going back to our definition of ignore, here are some reasonable questions that a lawyer might pose in a trial:
1. Sir, have you evidence that Prof. Mitchell has refused to take notice of or acknowledge the concepts of inflation, the Phillips curve, open economy considerations etc in his body of work spanning some 32 years of published material?
2. Sir, have you evidence that Prof. Mitchell has intentionally disregarded the concepts of inflation, the Phillips curve, open economy considerations etc in his body of work spanning some 32 years of published material?
2. Sir, have you evidence that Prof. Mitchell has failed to consider the concepts of inflation, the Phillips curve, open economy considerations etc in his body of work spanning some 32 years of published material?
Sir, I would suggest the answer to each question is an emphatic no – which means you might as well shut the F&&K up and apply yourself to reasonable levels of scholarship in the future.
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.