It’s Wednesday and I just finished a ‘Conversation’ with the Economics Society of Australia, where I talked about Modern Monetary Theory (MMT) and its application to current policy issues. Some of the questions were excellent and challenging to answer, which is the best way. You can view an edited version of the discussion below and…
I am now using Friday’s blog space to provide draft versions of the Modern Monetary Theory textbook that I am writing with my colleague and friend Randy Wray. We expect to complete the text during 2013 (to be ready in draft form for second semester teaching). Comments are always welcome. Remember this is a textbook aimed at undergraduate students and so the writing will be different from my usual blog free-for-all. Note also that the text I post is just the work I am doing by way of the first draft so the material posted will not represent the complete text. Further it will change once the two of us have edited it.
Chapter 13 – Buffer Stocks and Price Stability
[Continuing from Part 2]
The employment buffer stock approach – which is referred to in the literature as the Job Guarantee (JG) – defines a policy framework where the government operates a buffer stock of jobs to absorb workers who are unable to find employment in the private sector.
Analogous to the central bank’s function of lender of the last resort, the JG functions as a buffer which absorbs all potential employment, at an acceptable minimum wage. In this sense, the government acts as an employer of the last resort.
While it is easy to characterise the JG as purely a public sector job creation strategy, it is important to appreciate that it is actually a macroeconomic policy framework designed to deliver full employment and price stability based on the principle of buffer stocks where job creation and destruction is but one component.
Under a JG, the government thus provides an unconditional, open-ended job offer at a given wage to anyone who desires to work. Instead of a person becoming unemployed when aggregate demand falls below the level required to maintain full employment, the person would enter the JG workforce.
The JG pool expands (declines) when private sector activity declines (expands). The JG thus fulfills an absorption function, which minimises the costs associated with the flux of the economic activity as aggregate demand fluctuates.
In the event of a decline in aggregate demand, total demand for non-JG labour workers declines according the employment requirements function we defined in Chapter 9. In this situation, the workers who were displaced from their jobs would have an option – accept a JG position or wait for conditions to improve in the non-JG economy.
It is clear that the choice facing workers will be influenced by several factors. First, the government may offer workers the choice between the JG wage and the unemployment benefit, the latter being lower. Second, some workers, especially those in higher-skilled positions, may receive redundancy payments and use these to support themselves through the spell of unemployment. Economists call this response – wait unemployment. Some workers may feel that accepting a low-skill JG job would disadvantage them professionally and thus wait for circumstances to improve.
We assume for the moment that the Job Guarantee policy does not offer an unemployment benefit and that most displaced workers will prefer a JG position over wait unemployment. These assumptions serve to simplify the analysis and relaxing them does not alter the basic dynamics of the system.
When private economic activity picks up, workers would be bid out of the JG pool by employers and the buffer stock of jobs would contract.
The JG wage
Why would workers accept these bids? The “buffer stock” employees would be paid an minimum wage, which would define the level of income necessary for a full-time worker to enjoy an adequate social and material existence.
The nation always remains fully employed, with only the mix between private and public sector employment fluctuating as it responds to the spending decisions of the private sector. Since the JG wage is open to everyone, it will functionally become the national minimum wage.
While it is preferable to avoid disturbing the private sector wage structure when the JG is introduced, a case can be made to offer the JG wage at a level higher than the existing private minimum if it is thought that productivity is too low in the economy.
This is particularly relevant in developing economies where many market-based jobs pay wages that are below the poverty line and provide no incentives for employers to invest in more productive capital or for workers to invest in human capital.
The minimum wage should not be determined by the capacity to pay of the private sector. It should be an expression of the aspiration of the society of the lowest acceptable standard of living. Any private operators who cannot “afford” to pay the minimum should exit the economy
The Government would supplement the JG earnings with a wide range of social wage expenditures, including adequate levels of public education, health, child care, and access to legal aid. Further, the JG policy does not replace conventional use of fiscal policy to achieve social and economic outcomes.
In general, the JG would be accompanied by higher levels of public sector spending on public goods and infrastructure. These supplements would be in addition to the scheme but not essential for the scheme to function effectively.
The JG as an automatic stabiliser
The JG wage thus defines the wage floor for the economy and serves as an automatic stabiliser, similar to the tax system.
Recall that automatic stabilisation refers to the components of the government budget, which rise and fall as the economic cycle fluctuates without there being any explicit change in government spending or tax settings.
They operate to stabilise the economic cycle providing a floor in the fall in aggregate demand during an economic downturn and a ceiling in the demand as the economy grows. At full employment, the automatic stabiliser component of aggregate demand is zero.
Thus, when the economy is in decline, tax revenue falls and welfare payments rise which expands the budget position of the government automatically. The introduction of the JG would have the same counter-cyclical impact. When the economy was faltering, the spending associated with the JG would rise and vice-versa when times were good.
In this regard, the JG is a superior (more powerful) automatic stabiliser than a system of unemployment benefits (under the unemployment buffer stock option) because aggregate demand slumps less and therefore the positive impact on real output is greater than would be the case if the government merely paid unemployment benefits.
Automatic stabilisers have the desirable characteristic of providing immediate, counter-cyclical spending injections (or withdrawals) when private activity fluctuates. They avoid the so-called policy lags which relate to the time delays in the government identifying that a significant shift in private demand has occurred, designing a policy response to that shift, providing appropriate legislation to support an intervention, and then executing the intervention.
In some cases, the time delays can result in the major part of the policy intervention arriving too late and working to destabilise the cycle. For example, if by the time the government has designed and implemented a new discretionary spending injection, the private sector has already resumed trend spending growth, then the impulse of government spending might lead to the economy overheating.
The fixed wage offer that defines the JG policy also serves to stabilise the growth rate in money wages in the economy and thus provides a nominal anchor against inflation.
Advanced material: Buffer stocks in Agriculture
Buffer stocks have long been used in agriculture and commodity production. The JG bears many similarities (and a significant difference) with agricultural price support buffer stock schemes that governments have regularly used to stabilise prices and incomes in the agricultural sector.
For example, in November 1970, the Australian Government introduced the Wool Floor Price Scheme. The scheme was relatively simple and worked by the Government establishing a floor price for wool after hearing submissions from the Wool Council of Australia and the Australian Wool Corporation (AWC).
The aim of the system was to stabilise farm incomes and led to an agreed price for wool being paid to the farmers. The Government then stabilised the private at this guaranteed level by using the AWC to purchase stocks of wool in the auction markets if demand was low and selling it if demand was high.
By being prepared to hold “buffer wool stocks” in times of low demand and release them again in times of high demand the government was able to guarantee incomes for the farmers around the stable price.
The contention that ultimately led to the demise of the system was whether the guarantee constituted a reasonable level of output in a time of declining demand. Farmers clearly had an incentive to over-produce wool knowing that the government would buy any excess not demanded by the auction markets.
The JG approach is also based on the maintenance of a variable buffer stock of jobs in line with fluctuations in private demand. However, the weaknesses of the agricultural scheme do no apply to a JG.
First, if there is a price guarantee below the prevailing market price (the JG wage) and a buffer stock of working hours constructed to absorb the excess supply at the current market price, then a form of full employment can be generated without tinkering with the price structure.
Second, the incentives to over-production in commodity buffer stock systems do not apply to maintaining a labour buffer stock as no one is concerned that employed workers would have more children than unemployed workers.
Benjamin Graham wrote in the 1930s about the idea of stabilising prices and standards of living by surplus storage. He documents how a government might deal with surplus production in the economy (GET EXACT REFERENCE):
In the context of an excess supply of labour, governments now tend to choose the dumping strategy via the unemployment buffer stock approach (the NAIRU). However, it is less wasteful to use the conservation approach, which is reflected in the JG framework.
Graham (1937: 34) noted:
This distinction is important when we conceive of the way employment buffer stock models might work in practice. The Australian Wool Scheme was an example of storage for future sale and was not motivated to help the consumer of wool but the producer.
The JG policy is an example of storage for use where the “reserve is established to meet a future need which experience has taught us is likely to develop” (Graham, 1937: 35).
Inflation control and the JG
While introducing a public sector job creation capacity to the economy, the JG is better thought of as a macroeconomic policy framework designed to ensure that full employment and price stability is maintained over the private sector economic cycle.
The JG jobs would ‘hire off the bottom’, in the sense that minimum wages are not in competition with the market-sector wage structure. By not competing with the private market, the JG would avoid the inflationary tendencies of old-fashioned Keynesianism, which attempted to maintain full capacity utilisation by ‘hiring off the top’ (that is, making purchases at market prices and competing for resources with all other demand elements).
What are the mechanics of inflation control under a JG? In Chapter 12, we examined the way in which incompatible claims over the available real income could cause wage-price pressures to escalate into an inflationary episode as the claimants (labour and capital) attempted to defend their real income shares.
In an unemployment buffer stock system the approach to price control uses unemployment to discipline wage demands by workers and to soften the product market to discourage profit-margin push by firms as a means of curbing wage-price pressures and maintaining stable inflation.
The JG approach stands in contradistinction to the NAIRU approach. When the level of private sector activity is such that wage-price pressures forms as the precursor to an inflationary episode, the government manipulates fiscal and monetary policy settings (preferably fiscal policy) to reduce the level of private sector demand.
Labour is then transferred from the inflating private sector to the “fixed wage” JG sector, which would eventually the inflation pressures. The can be no inflationary pressures arising from a policy that sees the Government offering a fixed wage to any labour that is unwanted by other employers.
The JG involves the Government “buying labour off the bottom” rather than competing in the market for labour. By definition, the unemployed have no market price because there is no market demand for their services. The JG just offers a wage to anyone who wants it and places no market pressure on wages.
WE WILL CONTINUE THIS NEXT WEEK
THE REST OF THIS MATERIAL WILL BE FAMILIAR – BUT I WILL COMPLETE IT NEXT WEEK FOR THE SAKE OF OUR DRAFT WHICH IS GETTING CLOSER TO COMPLETION NOW.
Case Study: Britain and the 1976 IMF Loan
[NOTE: We are putting this Case Study into the book as it marks an important historical point in the full employment debate and the rise of monetarism]
NEXT WEEK I WILL ADVANCE THE BRITISH-IMF CASE STUDY. I HAVE A MASSIVE COLLECTION OF DOCUMENTS AND OLD SCANS THAT I HAVE COLLECTED OVER THE YEARS ABOUT THIS INCIDENT INCLUDING THE EXCELLENT BRITISH TREASURY FREEDOM OF INFORMATION REQUEST DOCUMENT SET.
WE WILL TALK ABOUT THIS NEXT WEEK.
The Saturday Quiz will be back again tomorrow. It will be of an appropriate order of difficulty (-:
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.