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Buffer stocks and price stability – Part 5

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.

Previous parts to this Chapter:

Chapter 13 – Buffer Stocks and Price Stability

[Continuing from Part 4]

Would the NAIBER will be higher than the NAIRU?

We have learned that the NAIRU defines the unemployment buffer stock associated with stable inflation whereas in the employment buffer stock approach to price stablity, the Non-Accelerating Inflation Buffer Employment Ratio (NAIBER) is the BER that results in stable inflation via the redistribution of workers from the inflating private sector to the fixed price JG sector.

An interesting question to explore relates to the relative sizes of the NAIBER vis-à-vis the NAIRU. There are two arguments that might be used to argue that the NAIBER would have to be larger than the NAIRU for an equivalent amount of inflation control?

There are two strands to this argument. First, the intuitive but somewhat inexact view is that because JG workers will have higher incomes (than when they were unemployed) a switch to this policy would always see demand levels higher than under a NAIRU world.

As a matter of logic then, if the NAIRU achieved output levels commensurate with price stability then, other things equal, a higher demand level would have to generate inflationary impulses. So according to this view, the level of unemployment associated with the NAIRU is intrinsically tied to a unique level of demand at which inflation stabilises.

Second, and related, it is claimed that the introduction of the JG reduces the threat of unemployment which serves to discipline the wage setting process. The main principle of a buffer stock scheme like the JG is straightforward – it buys off the bottom (at zero bid) and cannot put pressure on prices that are above this floor. The choice of the floor may have a once-off effect on the existing price level only.

It should be noted that while it is clear that JG workers will enjoy higher purchasing power under a JG compared to their outcomes under a NAIRU policy, it is not inevitable that aggregate demand overall would rise with the introduction of JG.

But assuming aggregate demand is higher when the JG is introduced than that which prevailed in the NAIRU economy, we might wonder why inflation is not inevitable as we replace unemployment with (higher paying) employment.

Rising demand per se does not necessarily invoke inflationary pressures because by definition the extra liquidity is satisfying a net savings desire by the private domestic sector.

Additionally, in demand constrained economies, firms are likely to increase capacity utilisation to meet the higher sales volumes rather than risk losing market share by increasing prices. There would be no obvious cost pressures forcing the firms to increase prices.

Further, the aggregate demand impulse required to return the economy to what we might call “loose” full employment under the JG is less than would be required in a NAIRU economy where the government would have to pay market prices to bring the idle resources back into productive use.

In that context, it is clear that if there were any demand-pull inflation it would be lower under the JG. So there are no new problems faced by employers who wish to hire labour to meet the higher sales levels.

Additionally, any initial rise in demand will stimulate private sector employment growth while reducing JG employment and spending.

The impact on the price level of the introduction of the JG will also depend on qualitative aspects of the JG pool relative to the NAIRU unemployment buffer. It is here that the so-called threat debate enters.

In the NAIRU logic, workers may consider the JG to be a better option than unemployment. Without the threat of unemployment, wage bargaining workers then may have less incentive to moderate their wage demands notwithstanding the likely disciplining role of wait unemployment in skilled labour markets.

However, when wait unemployment is exhausted private firms would still be required to train new workers in job-specific skills in the same way they would in a non-JG economy.

The functioning and effectiveness of the buffer stock in question is critical to its function as a price anchor. There is overwhelming evidence that long-term unemployment generates costs far in excess of the lost output that is sacrificed every day the economy is away from full employment.

It is clear that the more immediately employable are the unemployed the better the price anchor will function. After an extended downturn the unemployment buffer stock will be composed of a significant proportion of long-term unemployed.

JG workers are far more likely to have retained higher levels of skill than those who are forced to succumb to lengthy spells of unemployment. It is thus reasonable to assume that an employer would consider a JG worker, who is already demonstrating commitment to working, a superior training prospect relative to an unemployed and/or hidden unemployed worker.

The JG policy would thus reduce the hysteretic inertia embodied in the long-term unemployed and allow for a smoother private sectore expansion. Therefore JG workers would constitute a more credible threat to the current private sector employees than, say, the long-term unemployed.

When wage pressures mount, an employer would be more likely to exercise resistance if she knew she could hire from the fixed-price JG pool.

This changes the bargaining environment rather significantly because the firms now have reduced hiring costs. Previously, the same firms would have lowered their hiring standards and provided on-the-job training and vestibule training in as the labour market tightened.

As a consequence, longer term planning with cost control would be enhanced. So in this sense, the inflation restraint exerted via the NAIBER is likely to be more effective than using a NAIRU strategy.

In summary, the JG buffer stock is likely to be a qualitatively superior inflation fighting pool than the unemployed stock under a NAIRU. In that sense, the NAIBER will be lower than the NAIRU which means that employment can be higher before the inflation barrier is reached.

Another associated factor relates to the behaviour of professional occupational markets. In those markets, while any wait unemployment will discipline wage demands, the demand pressures may eventually exhaust this stock and wage-price pressures may develop.

With a strong and responsive tertiary education sector combined with strong firm training processes skill bottlenecks can be avoided more readily under the JG than with an unemployed buffer stock in place. The JG workers would be already maintaining their general skills as a consequence of an on-going attachment to the employed workforce.

The qualitative aspects of the unemployed pool deteriorate with duration making the transition back in the labour force more problematic. As a consequence, the long-term unemployed exert very little downward pressure on wages growth because they are not a credible substitute.

Open Economy Impacts:

The JG requires a flexible exchange rate to be effective. A once-off increase in import spending is likely to occur as JG workers have higher disposable incomes.

In most nations, the impact would be modest. We would expect any modest depreciation in the exchange rate to improve the contribution of net exports to local employment as explained in Chapter 16.

Employment buffer stocks and responsible fiscal design

In an open economy, if there was no government spending or taxation (that is, a budget balance of zero) the level of economic activity (output) will be determined by private domestic spending (consumption plus investment) and net external spending (exports minus imports). If one or more of those spending sources declines, then activity will decline.

In Chapters 7 and 8, we learned that a spending gap is defined as the spending required to create demand sufficient to elicit an output level, which at current levels of productivity, will provide enough jobs (measured in working hours) for all the workers who desire to work.

A zero spending gap occurs when there is full employment. We assume that there is no capacity-constrained unemployment where the level of capital stock is unable to support enough jobs to satisfy the available labour supply at existing productivity levels.

The role of aggregate government policy interventions is to ensure there is no spending gap. If we assume that monetary policy changes are relatively ineffective as a counter-stabilisation policy tool, then if private spending declines from a given position of full employment, the only way that the spending gap can be filled is via a fiscal stimulus – directly through government spending and/or indirectly, via a tax cut, which will increase private disposable income and stimulate subsequent private spending.

To recapitulate the essence of the income-expenditure framework developed earlier, the sources of expenditure, which sum to aggregate demand are:

  • Household consumption (C)
  • Private Investment (I)
  • Government spending (G)
  • Export revenue (X)

The income payments to resource owners involved in the production of output generated by these spending flows can be used in the following ways:

  • Household consumption (C)
  • Household saving (S)
  • Taxation payments (T)
  • Import spending (M)

Clearly, the sources of income have to equal the uses (as a convention of the National Accounts). As we learned in Chapter 6 on sectoral accounting, this allows us to write the two sides of income generation like this:

(13.2)      C + I + G + X = C + S + T + M

Given C cancels out we know that:

(13.3)      I + G + X = S + T + M

The left-hand side (I + G + X) are called injections – because they inject new demand into the economy whereas the right-hand side (S + T + M) are leakages because they drain aggregate demand.

The left-hand side of this equation is always is brought into equality with the right-hand side via national income adjustments (that is, variations in the level of aggregate activity brought about by spending variations).

The way national income adjustments impact on the injections and leakages in the income-expenditure system is one of the first principles of macroeconomics.

So if for example, Private Investment increases (with G and X constant), aggregate aggregate demand rises and firms react by increasing output to meet the new orders.

In doing so they will increase employment and pay out more in wages overall. The increased income is then used by workers to consume more but also to increase saving (S), pay more tax (T) at current tax rates, and increase imports (M).

The economy will stop expanding in response to this stimulus once the change in Investment is equal to the sum of the changes in S, T and M. We identified this dynamic response and subsequent resolution with the expenditure multiplier and the movement to a new expenditure-income equilibrium.

A macroeconomy is thus in a steady-state (that is, at rest or in equilibrium) when the sum of the injections equals the sum of the leakages. Whenever this relationship is disturbed (by a change in the level of injections, however sourced), national income adjusts and brings the income-sensitive spending drains into line with the new level of injections. At that point the system is at rest.

Three points should be reiterated.

First, this position of “rest” does not necessarily and will rarely coincide with full employment. There is no automatic tendency in the capitalist monetary system for the economy to sustain or achieve full employment.

The system will adjust to dramatically lower levels of injections and come to rest even if there are high unemployment levels. We now appreciate that economies can settle at very high levels of unemployment and stay there unless the statis is disturbed by a new injection. Typically, if private spending is depressed then that intervention will have to come from a fiscal policy stimulus.

Second, when an economy is “at rest” and there is high unemployment, there must be a spending gap given that mass unemployment is the result of deficient demand.

Accordingly, if there is no dynamic which would lead to an increase in private (or non-government) spending then the only way the economy will increase its level of activity is if there is increased net government spending.

This means that the increasing government spending (G) has to more than offset the increased drain (leakage) coming from taxation revenue (T). That is, a budget deficit is needed if a non-government spending gap.

Third, this doesn’t mean that a budget deficit is always required. In some circumstances, a budget surplus might be the appropriate fiscal stance.

If the non-government decisions taken together (consumption and saving decisions by households, investment decisions by production firms and the outcomes of the external sector) indicate a desire to “net save” which might be written as:

(13.4)      I + X < S + M

then the only way the level of activity can be maintained on an on-going basis (at any rate of unemployment) is if G > T. That is a budget deficit is required on a continuous basis to sustain a given level of activity.

In this case, a budget deficit “finances” the desire by the non-government sector to save by maintaining sufficient demand to produce a level of income which will generate that level of net saving.

Responsible fiscal policy thus requires the following two conditions to be fulfilled:

1. The discretionary budget position (deficit or surplus) must fill the gap between the savings minus investment minus the gap between exports minus imports.

In notation this is given as:

(13.5)      (G – T) = (S – I) – (X – M)

So, for income to be stable, the budget deficit will equal the excess of saving over investment (which drains domestic demand) minus the excess of exports over imports (which adds to demand).

If the right-hand side of the equation: (S – I) – (X – M) – is in surplus overall – that is, the non-government sector is saving overall then the only way the level of national income can remain stable is if the budget deficit offsets that surplus.

A surplus on the right-hand side can arise from (S – I) > (X – M) (that is, the private domestic sector net saving being more than the net export surplus) or it could be associated with a net exports deficit (draining demand and adding foreign savings) being greater than the private domestic sector deficit (investment greater than saving) which adds to demand.

2. Most importantly, a stable level of national income doesn’t necessarily define a state of full employment.

We can define a full employment level of national income as that which is generated when all resources are fully utilised according to the preferences of workers and owners of land and capital etc.

Given that S, T and M are all positively related to the level of national income, there is a unique level of each of these flows that is defined at full employment. Changes in behaviour (for example, an increased desire to save per dollar earned) will change that “unique” level but for given behavioural preferences and parameters we can define levels of each.

We denote S(Yf), M(Yf) the corresponding flows that are defined at full employment income (Yf). We also consider investment to be sensitive to national income (this is outlined in the so-called accelerator theory) such that higher levels of output require more capital equipment for a given technology. So I(Yf) might be defined as the full employment flow of investment. We consider export spending to be determined by the level of World income.

Accordingly, Full-employment budget deficit condition for stable national income is written as:

(13.6)      (G – T) = S(Yf) + M(Yf) – I(Yf) – X

The sum of the terms S(Yf) and M(Yf) represent drains on aggregate demand when the economy is at full employment and the sum of the terms I(Yf) and X represents spending injections at full employment.

If the drains outweigh the injections then for national income to remain stable, there has to be a budget deficit (G – T) sufficient to offset that gap in aggregate demand.

If the budget deficit is not sufficient, then national income will fall and full employment will be lost. If the government tries to expand the budget deficit beyond the full employment limit (G – T)(Yf) then nominal spending will outstrip the capacity of the economy to respond by increasing real output and while income will rise it will be all due to price effects (that is, inflation would occur).

In this sense, MMT specifies a strict discipline on fiscal policy. If the goal is full employment and price stability then the full-employment budget deficit condition has to be met.

The question then arises: how do employment buffer stocks relate to this condition?

We used the term “loose” full employment in relation to the JG because the employment generated is at minimum wages. The government expands the JG pool by purchasing “off the bottom” of the labour market.

In that context, the automatic stabiliser response associated with the conduct of the JG represents the minimum fiscal shift that is required to maintain employment at its previous level in the face of a falling level of private demand.

The maintenance of the level of employment, however, is accomplished by increasing the BER. That is, more workers are working on minimum wage and less on market wages when the JG pool expands.

The government may decide that it has non-inflationary room to then expand non-JG employment via direct job creation in the career section of the public sector or by a general fiscal stimulus designed to increase private sector employment.

In this case, the actual deficit spending that will satisfy the full employment budget deficit condition varies according to the proportion of the deficit that is engaged in JG employment.


There are many other microeconomic factors that are relevant to a full understanding of how a Job Guarantee would work in practice. Questions relating to the type of jobs, the levels of government involved in funding and operations, the relationship with the existing income support system, the integration of training pathways into the policy, the role of trade unions, the choices available to workers for fractional employment, the capacity of the government to sack workers and more.

While these are important factors which have been dealt with in the literature, they lie outside of our macroeconomic focus in this textbook. More information can be found in the references at the end of this Chapter.

Saturday Quiz

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.

This Post Has 3 Comments

  1. “JG workers are far more likely to have retained higher levels of skill than those who are forced to succumb to lengthy spells of unemployment.” True if those JG workers are allocated to a TYPE OF WORK that employs their “skills”, but not otherwise.

    If unemployed teachers, car mechanics or bricklayers are allocated to planting trees or environmental clean ups (the sort of activity that Bill’s version of JG consists of as I understand it), there won’t be much “skill retention”.

  2. That’s not what the JG proposes, Ralph. As Wray writes somewhere, ‘Minsky always said that the ELR/ JG should take workers as they are’. That is, they should be employed at their specialty, insofar as possible. That’s what the spectacularly successful WPA did. For that’s what the WPA did when it employed Minsky- at estimating Cobb-Douglas production functions!

  3. Ralph,
    “True if those JG workers are allocated to a TYPE OF WORK that employs their “skills”, but not otherwise.”

    That doesn’t seem right to me. A brick-layer who looses his job and plants trees, can still lay bricks, but they are also learning to plant trees. Even in the fast-moving IT industry, it takes at least 6 months to begin to get behind in your IT skills, and anything you learn on JG just adds to your skills.

    I don’t interpret Bill’s phrase “higher level of skills” to mean the same skills they already have, but to include an increased mix of skills that make them more widely employable.

    Kind Regards

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