I am still catching up after being away in the UK last week. I will…
Structural fiscal balance is about full employment not ‘normality’
Already this morning I have received several E-mails asking me to comment on the latest article in the Sydney Morning Herald (February 3, 2014) – Budget a matter of timing and nerve – by its economics editor Ross Gittins. I prefer not to write a full blog about this because it will distract me from my Eurozone book that is running to a tight deadline before publishing. But I will make a short comment on what I see as symptomatic among financial and economics journalists – a laxity in their terminology, which either deliberately supports or involuntarily plays into the hands of those who seek to redefine full employment as something that allows austerity to look acceptable.
Gittins is writing about the up-coming debate about the May Federal fiscal announcement (aka as the B-word, which I no longer use). It will be the first statement of fiscal position by the newly-elected conservative government (after the September 2013 federal election) and they have been talking tough. We will see.
Gittins writes in the context of the government’s claim to have an “an almighty cleanout and strike a lasting blow for fiscal sustainability” that:
… it has to go further and achieve a significant net improvement in the “structural” budget balance (the balance we would have if this were a normal year in the business cycle).
The reference to the structural defict being the “the balance we would have if this were a normal year in the business cycle” is pure fiction and is not even to be found in mainstream economics. This is either a fiction Gittins chooses to perpetuate because he doesn’t know any better (not likely) or that he does not choose to explain the concept properly (probably).
The result though is that the most important aspect of defining the division in the government’s fiscal balance between structural and cyclical – the concept of full employment – is lost.
What exactly might he be thinking about a “normal year in the business cycle”? A business cycle, which I prefer to call an ‘economic cycle’ because economic activity comes from a broader source than the business sector, is made up of a peak, a trough and some amplitude in between.
It could mean an economy started with high unemployment, saw some fall in the same as the economy improved, and, after the peak, saw unemployment rise again, without ever get close along the way to having enough jobs available for all those who want to work.
Further, underemployment might remain high throughout this ‘economic cycle’.
So what would a “normal year” be in that experience?
The following provides you with an accurate understanding of what a stuctural fiscal balance is. It has nothing to do with a “normal year” in an economic cycle. In fact, if the fiscal balance is all structural then it would be a very unique year and one that nations rarely attain, mostly because governments will not take responsibility for achieving full employment.
The federal fiscal balance is the difference between total federal revenue and total federal outlays. So if total revenue is greater than outlays, the fiscal balance is in surplus and vice versa. It is a simple matter of accounting with no theory involved. However, the fiscal balance is used by all and sundry to indicate the fiscal stance of the government.
So if the fiscal balance is in surplus we conclude that the fiscal impact of government is contractionary (withdrawing net spending) and if the fiscal balance is in deficit we say the fiscal impact expansionary (adding net spending).
However, the complication is that we cannot then conclude that changes in the fiscal impact reflect discretionary policy changes. The reason for this uncertainty is that there are automatic stabilisers operating. To see this, the most simple model of the fiscal balance we might think of can be written as:
Fiscal Balance = Revenue – Spending.
Fiscal Balance = (Tax Revenue + Other Revenue) – (Welfare Payments + Other Spending)
We know that Tax Revenue and Welfare Payments move inversely with respect to each other, with the latter rising when GDP growth falls and the former rises with GDP growth. These components of the fiscal balance are the so-called automatic stabilisers
In other words, without any discretionary policy changes, the fiscal balance will vary over the course of the business cycle. When the economy is weak – tax revenue falls and welfare payments rise and so the fiscal balance moves towards deficit (or an increasing deficit).
When the economy is stronger – tax revenue rises and welfare payments fall and the fiscal balance becomes increasingly positive. Automatic stabilisers attenuate the amplitude in the economic cycle by expanding the budget in a recession and contracting it in a boom.
So just because the fiscal balance goes into deficit doesn’t allow us to conclude that the Government has suddenly become of an expansionary mind. In other words, the presence of automatic stabilisers make it hard to discern whether the fiscal policy stance (chosen by the government) is contractionary or expansionary at any particular point in time.
To overcome this uncertainty, economists devised what used to be called the Full Employment or High Employment Fiscal Balance.
In more recent times, this concept is now called the Structural Balance.
The change in nomenclature is very telling because it occurred over the period that neo-liberal governments began to abandon their commitments to maintaining full employment and instead decided to use unemployment as a policy tool to discipline inflation. I will come back to this later.
The Full Employment Fiscal Balance was a hypothetical construct of the fiscal balance that would be realised if the economy was operating at potential or full employment. You can see that this is different from the claim by Gittins that is is what would happen in some “normal year”.
In other words, calibrating the fiscal position (and the underlying fiscal parameters) against some fixed point (full capacity) eliminated the cyclical component – the swings in activity around full employment.
So a full employment fiscal balance would be in balance (that is, zero) if total outlays and total revenue were equal when the economy was operating at total capacity.
If the fiscal balance was in surplus at full capacity, then we would conclude that the discretionary structure of fiscal policy was contractionary and vice versa if the fiscal balance was in deficit at full capacity.
The calculation of the structural deficit spawned a bit of an industry in the past with lots of complex issues relating to adjustments for inflation, terms of trade effects, changes in interest rates and more.
Much of the debate centred on how to compute the unobserved full employment point in the economy. There were a plethora of methods used in the period of true full employment in the 1960s. All of them had issues but like all empirical work – it was a dirty science – relying on assumptions and simplifications. But that is the nature of the applied economist’s life.
Things changed in the 1970s and beyond. At the time that governments abandoned their commitment to full employment (as unemployment rise), the concept of the Non-Accelerating Inflation Rate of Unemployment (the NAIRU) entered the debate – see my blogs – The dreaded NAIRU is still about and Redefining full employment … again!.
The NAIRU became a central plank in the front-line attack on the use of discretionary fiscal policy by governments. It was argued, erroneously, that full employment did not mean the state where there were enough jobs to satisfy the preferences of the available workforce. Instead full employment occurred when the unemployment rate was at the level where inflation was stable.
NAIRU theorists then invented a number of spurious reasons (all empirically unsound) to justify steadily ratcheting the estimate of this (unobservable) inflation-stable unemployment rate upwards. So in the late 1980s, economists were claiming it was around 8 per cent. Now they claim it is around 5 per cent. The NAIRU has been severely discredited as an operational concept but it still exerts a very powerful influence on the policy debate. In Australia, it dominates the Treasury and the Reserve Bank modelling.
Further, governments became captive to the idea that if they tried to get the unemployment rate below the NAIRU using expansionary policy then they would just cause inflation. I won’t go into all the errors that occurred in this reasoning. My 2008 book – Full Employment Abandoned with Joan Muysken is all about this period.
Now I mentioned the NAIRU because it has been widely used to define full capacity utilisation. If the economy is running an unemployment equal to the estimated NAIRU then these clowns concluded that the economy is at full capacity. Of-course, they kept changing their estimates of the NAIRU which were in turn accompanied by huge standard errors. These error bands in the estimates meant their calculated NAIRUs might vary between 3 and 13 per cent in some studies which made the concept useless for policy purposes.
But they still persist in using it because it carries the ideological weight – the neo-liberal attack on government intervention.
So they changed the name from Full Employment Fiscal Balance to Structural Balance to avoid the connotations of the past that full capacity arose when there were enough jobs for all those who wanted to work at the current wage levels. Now you will only read about structural balances.
And to make matters worse, they now estimate the structural balance by basing it on the NAIRU or some derivation of it – which is, in turn, estimated using very spurious models. This allows them to compute the tax and spending that would occur at this so-called full employment point. But it severely underestimates the tax revenue and overestimates the spending and thus concludes the structural balance is more in deficit (less in surplus) than it actually is.
They thus systematically understate the degree of discretionary contraction coming from fiscal policy.
The point is that, even with all the NAIRU chicanery, there is nothing about the structural balance that denotes a “normal year” in the economic cycle.
My Euro Options blog for today will come later today.
Please read the following blogs for further elucidation:
I think the correct usage of the word “blog” goes as follows: “blog post” refers to individual posts and “blog” refers to the collection of posts as a whole. But given that you deliver one of the most detailed and important economics blogs on the internet you probably have the right to use the word however you please.
I agree with Bill’s article except that as usual he talks complete nonsense about NAIRU. First he claims that prior to the introduction of the term NAIRU (around 1970) there was some sort of golden age when “there were enough jobs to satisfy the preferences of the available workforce.” And in his forthcoming text book he makes much the same claim: he claims “all workers who wanted to work could find jobs.” So there was no unemployment prior to 1970? That claim is obvious nonsense.
NAIRU is simply a minor and not very important variation on the idea that preceded it, namely the so called “natural level” of unemployment. The latter claims that given excess demand, inflation rises to some fixed and unacceptably high level. In contrast, NAIRU claims that at that level of demand, inflation ACCELERATES.
Next, Bill himself has his own term, his so called “inflation barrier”, which amounts to the same thing as NAIRU / natural level. That’s the level of demand at which demand cannot be increased any further because inflation becomes unacceptable. Well there’s a level of employment that corresponds to that level, isn’t there? I.e. Bill’s “inflation barrier” is simply another name for NAIRU / natural level of unemployment.
Next, Bill’s claim that in the late 1970s and early 80s governments paid far too much attention to inflation and not enough to employment is bizarre given that inflation was around 8% at that time.
As to Bill’s claim that those wicked neo-liberals use the NAURU for their own ends, no doubt they do. Likewise in World War II those wicked Germans, British and Americans used airplanes to drop bombs on each other. That doesn’t prove there is something inherently wrong with airplanes.
“NAIRU is simply a minor and not very important variation on the idea that preceded it”
No it isn’t.
It is a propaganda term that mainstream economists like to try and equate to ‘light speed’. Something you can never go beyond as some law of nature.
Which of course the Job Guarantee concepts shows to be nonsense. You can employ everybody in the economy that wants a job very easily indeed once you wash your mind of inflexible thoughts.
Some people are rather too fond of sticking with something long after its meaning has been twisted for other purposes.
Similarly you wouldn’t continue to use the term ‘nigger’ for a person of black african decent, ‘spastic’ for somebody who has cerebral palsy, or ‘anarchist’ for somebody who just doesn’t believe we can have a government.
Your constant defence of NAIRU falls into the same category. The meaning has been altered beyond rescue. Time to stop using the term and move on.
Bill –
That shows why FE fiscal balance and structural fiscal balance are completely different! Admittedly it’s a difference that many who write about it fail to understand, but I really thought you would!
The structural fiscal balance is what the balance would be if the private sector were operating at maximum capacity.
Dear Ralph (at 2014/02/03 at 14:49)
As I have indicated previously, your grasp of the history of economic thought is – limited – to say the least. The inflation barrier is not a term that is similar to the natural rate of unemployment nor the NAIRU. There are only superficial resonances – that at some point of nominal demand there will be inflation. That is trivial. The introduction of the NRU/NAIRU concept into economic theory was a major shift and was attempting to restore the classical dichotomy or neutrality to economics.
This was the view that there was no opportunity for government to use increased nominal demand to alter the unemployment rate. Various versions of the neutrality theorem then are differentiated by whether they make this claim as an absolute (at all times) or as a long-run outcome (allowing for governments to reduce the unemployment rate in the short-run).
The invariance of the NRU/NAIRU – that is, that the level of activity doesn’t alter the steady-state unemployment rate – is central to the concept and was not considered to be relevant or valid prior to the late 1960s when Milton Friedman started outlining the natural rate hypothesis.
Prior to that (in the post WWII period) it was believed that the equilibrium of the economy was sensitive to the level of activity – and this idea became known as hysteresis. Even Edmund Phelps, who also contributed significantly to the development of the NRU/NAIRU literature (an important article in 1967) acknowledged the variance of the NRU but that observation was lost in the subsequent mainstream free market literature that was intent on discrediting any government attempts to lower unemployment.
You should read a lot more before you start providing 100 word summaries of the history of economic thought.
best wishes
bill
“In other words, without any discretionary policy changes, the fiscal balance will vary over the course of the business cycle.”
Economic cycle?
Dear Aidan (at 2014/02/03 at 17:47)
You asserted without reference:
That is false and not reflected in the economic literature.
The structural balance refers to the activity of the entire economy because government employment produces tax revenue and has a cyclical effect on the final fiscal outcome!
best wishes
bill
“The structural fiscal balance is what the balance would be if the private sector were operating at maximum capacity.”
In a pure private economy – which we don’t have. In fact the whole concept of a ‘rate of unemployment’ beyond which you cannot go is an admission that a pure private economy cannot employ everybody.
In other words an admission of failure of the entire market idea concept.
In any mixed economy the amount of unemployment is a policy choice, since the government can just switch spending from one set of people to another using its policy tools. So you implement a Job Guarantee which employs everybody and, where necessary, halt private sector expansion before it causes demand pull inflation.
Trying to suggest that ‘structural’ and ‘full employment’ balances are different in a mixed economy is an attempt to belittle the role of government and make it ‘just another actor’. It tries to remove the unspoken assumption that we are trying to create a full employment economy. And that is a political and propaganda technique rather than an economic one.
It has been suggested to me in the past that the RBA does not take the NAIRU seriously – at least not any more:
http://ausmmt.tumblr.com/post/62578636221/rba-governor-seems-to-match-what-bruno-and
Kind regards,
Senexx
Neil,
Re your “propaganda” point, I dealt with that above. To repeat, neo-liberals may well mis-use the NAIRU concept for their own ends. That has precisely and exactly nothing to do with the validity or otherwise of the concept. The fact that airplanes were used to drop bombs in WWII does not prove that airplanes per-se are undesirable.
Re JG, we’re all perfectly well aware that JG can be used to take unemployment below NAIRU/the natural level. That’s a statement of the obvious. I was assuming above that non conventional employment measures like JG are not used. I thought that was so obvious I didn’t need to spell it out. Moreover, given that JG can in theory employ just about everyone, then that invalidates Bill’s “inflation barrier” concept as much as it does NAIRU or the natural level concept.
Re your suggestion that “meaning of NAIRU has been altered beyond rescue” I suggest you look up the term in some online dictionaries of economics (which I’ve just done). The meaning hasn’t changed at all. Plus the online dictionaries give the same definition as my Oxford Dictionary of Economics published in 2004. Those definitions say nothing about NAIRU being some sort of evil plot by neo-liberals to impose their ideology. It’s only in the minds of Bill Mitchell and his followers that NAIRU incorporates evil plots.
Bill,
If my understanding of NAIRU is flawed, the so too is this economics tutorial site’s, whose description of NAIRU coincides with my understanding of the term:
http://tutor2u.net/economics/content/topics/unemp/nairu.htm
Perhaps you better contact them.
They say (and I agree) that NAIRU is simply the idea that at some level of unemployment, inflation takes off (absent unconventional employment measures like JG).
As to your claim that the NAIRU concept includes the idea that “no opportunity for government to use increased nominal demand to alter the unemployment rate”, the above site says nothing about that. What they do say is “Friedman’s view was that governments could not permanently attempt to drive unemployment down below the NAIRU – the result would be higher inflation..”. I agree.
Moreover, if Friedman thought that governments cannot in any way influence employment, then why did he SPECIFICALLY ADVOCATE a method whereby government could keep employment as high as possible without exacerbating inflation: namely having a steady annual increase in the money supply???
And why did he argue that the 1930s depression was the fault of the Fed? He was saying that the Fed / government very clearly CAN INFLUENCE demand and employment levels wasn’t he? And I agree with him.
Dear Ralph (at 2014/02/03 at 19:18)
If you want to proclaim expertise in economic theory and the history of economic thought please read the relevant primary literature to start with rather than an Internet site.
best wishes
bill
Neil Wilson
The exact opposite is true: it attempts to properly acknowledge the difference between the roles of the government and the private sector.
No, the assumption it tries to remove is that the deficit required to create full employment is always structural.
Ralph, and others, may find this paper informative:
,
It is high time to ditch the NAIRU
SERVAAS STORM AND C.W.M. NAASTEPAD
The authors are affiliated with the Department of Economics, Delft University of
Technology, Delft, the Netherlands, s.t.h.storm@tudelft.nl.
Abstract: According to the mainstream theory of equilibrium unemployment,
persistent unemployment is caused (mainly) by “excessive” labor market
regulation, whereas aggregate demand, capital accumulation, and technological
progress have no lasting effect on unemployment. We argue that the
mainstream nonaccelerating inflation rate of unemployment (NAIRU) model is
only a special case of a general model of equilibrium unemployment, in which
aggregate demand, investment, and endogenous technological progress have
long-term effects. It follows that the labor market policy prescriptions (i.e., to
drastically deregulate), following from the standard NAIRU model, can by no
means be generalized. Empirical support for the general model is provided by
an econometric analysis for 20 Organization for Economic Cooperation and
Development (OECD) countries (1984-97): demand factors are the overriding
determinants of structural unemployment in the OECD.
Journal of Post Keynesian Economics / Summer 2007, Vol. 29, No. 4 531
“No, the assumption it tries to remove is that the deficit required to create full employment is always structural.”
That clearly begs the question.
You are entitled to your view. I disagree with it.
“They say (and I agree) that NAIRU is simply the idea that at some level of unemployment, inflation takes off”
And it says in the Oxford English Dictionary that nigger is simply a black person.
Dear Bill (at 2014/02/03 at 17:52)
I’m basing my claims on the assumption that the structural deficit is the structural component of the deficit. Is that incorrect? If so, what should the structural component of the deficit be referred to as?
If the assumption is correct then I concede my claim isn’t entirely true… because I haven’t taken profits into account. But these are likely to be higher in the boom, in which case I’ve understated the difference between the full employment fiscal balance and the structural fiscal balance.
Government employment produces tax revenue, but no more so than private sector employment – but the former usually affects government spending whereas the latter usually doesn’t (though I admit it gets a bit complicated with government funding of private sector spending and vice versa).
And government spending, normally and rightly, has a countercyclical effect on the final fiscal outcome.
Consider the fiscal effects of immediately introducing a JG: the deficit would immediately shoot up. Then with full employment, demand would increase, the private sector would employ more people, so the deficit would come down. It may well continue to fall, and in a few years we could reach a surplus. Possibly even a big surplus. But if Chinese demand collapses, the private sector would probably lay off a lot of people who’d then immediately be emoloyed in the public sector and we’d be back with a big deficit. If, under those circumstances, suppose the government balance was…
Year 1: hude deficit
Year 2: medium deficit
Year 3: small deficit
Year 4: small surplus
Year 5: large surplus
Year 6: large deficit
…would you categorise all that as structural? Because we’d have full employment, but it looks cyclical to me.
Dear Aidan (at 2014/02/03 at 21:37)
All this amounts to is that your original assertion that the structural balance refers to the private sector exclusively was incorrect as pointed out.
best wishes
bill
Neil Wilson
Far from clear, but I’m guessing you meant to ask whether it’s always cyclical. The answer is no.
Dear bill (at 2149)
Not quite all: it also amounts to that your original assertion that the full employment fiscal balance and the structural balance are the same concept is false.
Neil,
Re your claim that the dictionary definition of the word “nigger” is simply a “black person”, why not look up the word first before making that ridiculous statement? My Concise Oxford Dictionary says amongst other things “The word nigger has long had strong offensive connotations and is today one of the most racially offensive words in the language.”
And the Free Online Dictionary says “Used as a disparaging term for a Black person”.
In contrast, the dictionaries of economics that define NAIRU do not contain the disparaging characteristics that Bill attaches to the term NAIRU. I.e. Bill is simply not using the term as it is generally defined or understood.
Time to Ditch the NAIRU
James K. Galbraith
Source: Journal of Economic Perspectives-Volume 11, Number 1-Winter 1997-Pages 93-108
Link: http://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.11.1.93
Current NAIRU estimates are not credible, regardless of its definition.
Dear Bill,
Thanks for your suggestion that I should read “relevant primary literature to start with rather than an Internet site.” Any such “primary literature” is irrelevant because the purpose of my citing that economics tutorial site was simply to give an example of how the term NAIRU is actually used (and by a reasonably authoritative source). But just to make sure I’m right, I’ve just looked up the term in two popular economics text books (each about 700 pages). That’s Lipsey’s Principles of Economics and John Sloman’s “Economics”. Again, their depiction / explanation of NAIRU is the same as mine: i.e. simply the idea that at some level of unemployment, demand pull inflation takes off.
However, I did actually go back to “primary sources” to some extent in my above comment: that’s where a made some points about Friedman. I notice you haven’t answered those points.
Next, if you want to discard the term NAIRU, what are you going to put in its place to express the idea that there is some sort of relationship between inflation and unemployment? (Unless you’re claiming there is no relationship at all.) I took it your alternative term was “inflation barrier”. But now you say it’s not. So what’s your alternative term?
Ah. Another light bulb moment. Thank you.
Ralph, two thoughts:
Back in the 1970s, sure there was unemployment. But I had three jobs – two full-time (one of which was permanent dog-watch) plus part-time weekend. Were there 1600 hours in a week, I would have had 30 concurrent jobs by just rolling in off the street and asking. It was that easy. Walk in, “can I work?” – start there and then. Fewer “bullshit” jobs in those days, too. You know, the jobs that now stand between work and those who just want it.
Secondly, neo-liberals are wicked.
Phillwv,
Yes, I think everyone appreciates that finding work prior to about 1970 was much easier than after that date.
Re neo-liberals being wicked, I accepted that point above. Or rather I think it’s a mixture of wickedness and ignorance. Plus I agreed above that neo-libs use the NAIRU concept for their own ends. But that’s not surprising: whatever society you’re born into, you use the existing set of ideas prevalent in that society to further your own ideology (if you’re into the business of pushing a particular ideology).
Why is it necessary to have any monetary system at all. Why should not everyone get a fair share of
collectively produced and distributed goods and services for their collective labors.
All labor in this entire world is an expense of business that has to be added into the other expenses such as energy, housing for said businesses, transportation, communication, etc. Then each and every business must ask a higher price for all goods and services to cover all of the expenses plus a little extra for profit. This means that all the laborers who are also the consumers must pay a higher price for everything that they try to purchase than what they were paid to manufacture and distribute said purchases. What this means is that laborers are being shortchanged for their labor. Since laborers are not able to purchase all the goods and services which they collectively labor to produce and distribute, many items remain on shelves and create a monetary shortage for the companies to pay their expenses of which their laborer’s pay is one.
This creates a vicious cycle. On the one hand, points of distribution can’t sell all of the products that are manufactured by all of the different businesses that they distribute for; while on the other hand, laborers/consumers are unable to pay for these goods and services that they have collectively labored to produce and distribute. The only way that this will temporarily work is for businesses and laborers/consumers to go into some kind of debt.
And this is what the international money crowd waits for. Whichever way you slice it or dice it, this is the outcome-what we are all seeing in this sad little world today. The international money crowd just sits and slops up the interest, draining the rest of us of our energy and our life. You can try millions of different ways to fix it. But the money changers in the temple will be right there controlling the medium between the fruits of their labor and the human population. God is going to get rid of it. When money (Babylon) falls, it will never be used again. After all, why should mankind work to produce and distribute all of these goods and services and then wait for a group of people to give them some stupid money so that then they can have access to them.