This is the third and final part of my response to an article posted by American political analyst Jared Berstein (January 7, 2018) – Questions for the MMTers. In this blog I deal with the last question that he poses to Modern Monetary Theory (MMT) economists, which relates to whether currency issuing governments have to raise revenue in order to “pay for public goods” and whether prudent policy requires the cyclically-adjusted fiscal balance to be zero at full employment to ensure “social insurance programs” are protected. The answer to both queries is a firm No! But there are nuances that need to be explained in some detail. While Jared Bernstein represents a typical ‘progressive’ view of macroeconomics and is sympathetic to some of the core propositions of MMT, this three-part series
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This is the third and final part of my response to an article posted by American political analyst Jared Berstein (January 7, 2018) – Questions for the MMTers. In this blog I deal with the last question that he poses to Modern Monetary Theory (MMT) economists, which relates to whether currency issuing governments have to raise revenue in order to “pay for public goods” and whether prudent policy requires the cyclically-adjusted fiscal balance to be zero at full employment to ensure “social insurance programs” are protected. The answer to both queries is a firm No! But there are nuances that need to be explained in some detail. While Jared Bernstein represents a typical ‘progressive’ view of macroeconomics and is sympathetic to some of the core propositions of MMT, this three-part series has shown that the gap between that (neoliberal oriented) view and Modern Monetary Theory (MMT) is wide. I hope this three-part series might help the (neoliberal) progressives to abandon some of these erroneous macroeconomic notions and move towards the MMT position, which will give them much more latitude to actually implement their progressive policy agenda. For space reasons, I have decided to make this a three-part response. I also hope the three-part series have helped those who already embrace the core body of MMT to deepen their knowledge and render them more powerful advocates in the struggle against the destructive dominant macroeconomics of neoliberalism.
The final question that Jared Bernstein posed was couched in these terms:
A theme of my work, to which MMTers often object, I think, is that we need to raise more revenues to pay for public goods. I recently wrote, for example, that, given our aging population, it will take something like 3% more of GDP to meet our obligations to Social Security and Medicare/Medicaid by 2035. MMTers push back that as long as we’re below potential, we can print the money to support government spending, so stop getting so wound up about “payfors.”
But while assuming full employment is a mistake, so is assuming a) enough slack to warrant all that printing, and b) even more so, the political will to do so. Though we should always be willing to deficit spend in the near term when economic conditions warrant it, should we not structure long-term fiscal policy to avoid structural deficits (a structural deficit is one that persists even at full employment)? At least in a political sense of protecting vital social insurance programs, isn’t the prudent approach, as difficult politically as it may be, to try to lock in a level of revenue collection that meets our future obligations?
I have covered this question several times in the past – to counter the almost innate view held by progressives (deficit doves) who think that it might be acceptable to run fiscal deficits in a downturn but then want to run fiscal surpluses on the other side of the cycle to ‘pay back’ the deficits.
Various rules are proposed but they all amount to ‘balancing the fiscal position over the course of the economic cycle’ if not pushing for small net surpluses over the cycle.
It is a position that is embedded deeply among these ‘deficit doves’ yet essentially reflects an elemental misunderstanding of a range of issues.
The most complete account of my treatment of this issue is in this blog – The full employment fiscal deficit condition – which outlines the ‘rule’ that MMT economists consider appropriate for a currency-issuing government intent on advancing well-being, of which, full employment is a necessary condition.
To begin, the definition of what constitutes full employment has long been use as an ideological tool to cover poor policy.
There have been two striking developments in economics over the last thirty years. First, a major theoretical revolution occurred in macroeconomics (from Keynesianism to Monetarism and beyond). Second, unemployment and broader labour underutilisation rates have persisted at high levels.
In past work I have written about the development of the concept of full employment since the 1940s starting with the debate in the 1940s which emphasised the need to create enough jobs to absorb the available labour force.
In the 1950s, economists quickly shifted the focus and debated the magnitude of unemployment associated with full employment based on some spurious notion that if unemployment was too low then inflation would occur.
This led to the so-called Phillips curve era which was marked by policy makers contriving to achieve a politically acceptable trade-off between inflation and unemployment.
The Phillips curve is “god-like” in economics and represents the relationship between unemployment and inflation as a smooth inverse curve.
The underlying statistics that were used to get that curve (and since) are highly dubious. Anyway, in this period, fortuitous circumstances meant that unemployment remained low but the focus had clearly changed from generating a given quantity of jobs to being concerned about inflation.
Full employment as genuine policy goal was abandoned with the introduction of the so-called natural rate hypothesis (NRH) and its assertion that there is only one unemployment rate consistent with stable inflation.
In the NRH, there is no discretionary role for aggregate demand management and only microeconomic changes can reduce the natural rate of unemployment.
Accordingly, the policy debate became increasingly concentrated on deregulation, privatisation, and reductions in the provisions of the Welfare State with tight monetary and fiscal regimes instituted.
High unemployment persisted. The fact that quits were strongly pro-cyclical made the natural rate hypothesis untenable but that reality was overlooked because it was inconvenient to the ideologues in mainstream macroeconomics.
The idea of a cyclically-invariant steady-state unemployment rate persisted in the form of the NAIRU concept, first introduced in the mid-1970s.
The NAIRU was constructed as meaning that when unemployment is above it then inflation should decelerate and vice-versa.
While various theoretical structures have been used to justify the NAIRU as a viable concept, the conclusion from each is simple: there is only one cyclically-invariant unemployment rate associated with stable price inflation.
The NAIRU concept has dominated macroeconomic policy making in most OECD countries since the late 1970s and the ‘fight-inflation-first’ strategies have exacted a harsh toll in the form of persistently high unemployment and broader labour underutilisation.
Under the sway of the NAIRU, policy makers around the World abandoned the pursuit of full employment as initially conceived.
Of-course they couldn’t admit that so they started redefining what full employment meant.
So if you read this literature you will quickly realise that the neo-liberals define full employment as being the NAIRU which is divorced from any notion that there has to be enough jobs available to meet the desires of the available labour force.
So in one small change in taxonomy governments have been able to turn their failure to provide enough jobs into a success – well we are at full employment now because we are at the NAIRU.
The NAIRU is a pernicious concept indeed.
And we should not forget that the estimates of NAIRUs from time to time in most nations border on the ludicrous.
In other words, they are useless for determining whether an economy is at full employment and as a basis for policy interventions.
I found this article – Is Low Unemployment Inflationary? – very interesting when it first came out in 1997. It appeared in the Economic Review (82(1)) published by the Federal Reserve Bank of Atlanta.
The author, Roberto Chang, concluded that:
In practice, the concept of a nonaccelerating inflation rate of unemployment is not useful for policy purposes. First, the NAIRU moves around. Second, uncertainty about where the NAIRU is at any point of time is considerable. Third, even if we knew where the NAIRU were, it would be sub optimal to predict inflation solely on the basis of the comparison of unemployment against the NAIRU. A policy of raising the fed funds rate when unemployment falls below the NAIRU may be ineffective…even if the NAIRU were constant, its location were known and all shocks to the economy were to come from the demand side. Implementing such policy would likely induce changes in the expectations and behavior of the private sector an important additional reason to be skeptical about using the NAIRU for policy.
Please read my blogs (among others) for more discussion on this topic:
1. The dreaded NAIRU is still about! (April 16, 2009).
2. Full employment = mass idle labour – detaching language from meaning (June 20, 2016).
3. Full employment is still low unemployment and zero underemployment (June 17, 2013).
4. Full employment definition (December 21, 2012).
5. Redefining full employment … again! (May 5, 2009).
6. Why did unemployment and inflation fall in the 1990s? (October 3, 2013).
Full employment will always be defined as 1-2 per cent unemployment (to allow for movements between jobs and regions etc) and zero underemployment.
Modern Monetary Theory (MMT) offers a much better way of determining how much slack there is in the labour market.
By offering a Job Guarantee – the government knows the minimal volume of net spending that is required to provide jobs at a fixed wage for all workers that want to work but cannot find a job offer for their services.
The government knows that when the last worker enters the Job Guarantee office to apply for a job then it has achieved full employment.
At that point the policy intervention creates, by definition, ‘loose’ full employment. Why ‘loose’?
Because while it ensures everyone who wants to work can find a job at a socially-acceptable base income and can find the hours of work they desire (thus eliminating what we call ‘time-based’ underemployment), there would still be some ‘skills-based’ underemployment in the system.
That means that the Job Guarantee might employ a brain surgeon who is out of work due to cuts in health funding and that person might not be doing brain surgery within the public guaranteed jobs.
That person would be considered to be underemployed on the basis of their skills.
True (‘tight’ or ‘high pressure’) full employment would occur when all ‘skills-based’ underemployment is also eliminated.
My estimate is that in a strong economy which offers a buffer stock of jobs via a Job Guarantee, those in the guaranteed pool would not be highly skilled and so the extent of ‘skills-based’ underemployment would be very low.
But the point is that the fluctuations in the Job Guarantee pool provide a very reliable daily guide to the state of the overall labour market.
When the buffer stock Job Guarantee pool shrinks to historic low levels then it is likely that the labour market is approaching true full employment.
That observation would be buttressed by examining wage and price movements.
While I will analyse this in more detail tomorrow, the US Bureau of Labor Statistics yesterday (January 9, 2018) released their latest – Job Openings and Labor Turnover – November 2017 – data.
In Paul Krugman’s latest New York Times column (January 9, 2017) – Deficits Matter Again – he claimed that the US labour was close to full employment.
He made that claim as a posturing device to support his view that the current (low) fiscal deficits in the US were dangerous and hyperinflation was a risk.
How do we know that we’re close to full employment? The low official unemployment rate is just one indicator. What I find more compelling are two facts: Wages are finally rising reasonably fast, showing that workers have bargaining power again, and the rate at which workers are quitting their jobs, an indication of how confident they are of finding new jobs, is back to pre-crisis levels.
This bears on the discussion of what actually constitutes full employment.
Well, the latest JOLTS data does not really support Krugman’s assertions.
The following graph (and I will have more analysis of the US labour market situation tomorrow) shows the Non-farm hiring and quit rate for the US from December 2000 (the beginning of the JOLTS dataset) to November 2017 (the most recent data).
Both the hires rate and the quit rate are still below the pre-GFC levels and certainly well below the levels at the turn of the century.
Just those indicators alone, tell us that the US labour market has some slack left to absorb. More tomorrow on the data.
Jared Bernstein thinks that the US government needs:
… to raise more revenues to pay for public goods … given our aging population, it will take something like 3% more of GDP to meet our obligations to Social Security and Medicare/Medicaid by 2035
He then thinks that if the economy is at full employment (or close to that state), this need to raise revenue becomes imperative.
Firstly, the belief that the US government or any currency-issuing government needs “to raise more revenues to pay for public goods” is patently false.
The government might have elaborate accounting rules and smokescreens that make it look like they are putting tax receipts into a ‘spending’ account prior to the government withdrawing from that account when they spend but those arrangements are just disguising the intrinsic capacity of the currency-issuer.
The underlying reality is that a sovereign government is never revenue constrained because it is the monopoly issuer of the currency.
It could change the accounting rules any time it wanted – and, for example, require the US President to stand on his head for a minute before a public dollar can be spent each day.
But everyone would know that was stupid and unnecessary.
Well the same thing applies to the accounting arrangements and rules subject to tax revenue and spending.
A currency-issuing government does not need “to raise more revenues to pay for public goods”.
Secondly, that doesn’t mean that the imposition of taxes is not functionally related to public spending.
Not being ‘revenue-constrained’ means that a currency-issuing government can always purchase goods and services available for sale in that currency, which may include all idle labour resources.
The latter observation provides the capacity to run a Job Guarantee.
But, we need to be cautious.
Saying the government can always purchase goods and services available for sale in the currency it issues, is not the same thing as saying the government can always spend without concern for other dimensions in the aggregate economy.
For example, if the economy was at full capacity and the government tried to undertake a major nation building exercise with large expenditure to improve infrastructure then it might hit inflationary problems – it would have to compete at market prices for resources and bid them away from their existing uses.
In those circumstances, the government may – if it thought it was politically reasonable to build the infrastructure – quell demand for those resources elsewhere – that is, create some unemployment.
How? By increasing taxes and/or cutting spending.
Please read my blog – An MMT response to Jared Bernstein – Part 1 – for more discussion on this point.
This statement requires that we understand the role that taxes can play in a fiat currency system.
In a fiat monetary system the currency has no intrinsic worth. Further the government has no intrinsic financial constraint.
The starting point of this new understanding is that taxation functions to promote offers from private individuals to government of goods and services in return for the necessary funds to extinguish the tax liabilities that the government has the legal capacity to impose.
In this way, it is clear that the imposition of taxes creates unemployment (people seeking paid work) in the non-government sector and allows a transfer of real goods and services from the non-government to the government sector, which in turn, facilitates the government’s economic and social program.
The crucial point is that the funds necessary to pay the tax liabilities are provided to the non-government sector by government spending.
Accordingly, government spending provides the paid work which eliminates the unemployment created by the taxes.
This allows us to see why mass unemployment arises.
It is the introduction of State Money (government taxing and spending) into a non-monetary economics that raises the spectre of involuntary unemployment.
As a matter of accounting, for aggregate output to be sold, total spending must equal total income (whether actual income generated in production is fully spent or not each period).
Involuntary unemployment is idle labour offered for sale with no buyers at current prices (wages).
Unemployment occurs when the private sector, in aggregate, desires to earn the monetary unit of account, but doesn’t desire to spend all it earns, other things equal.
As a result, involuntary inventory accumulation among sellers of goods and services translates into decreased output and employment.
In this situation, nominal (or real) wage cuts per se do not clear the labour market, unless those cuts somehow eliminate the private sector desire to net save, and thereby increase spending.
The obvious conclusion is that unemployment occurs when net government spending is too low to accommodate the need to pay taxes and the desire to net save.
This analysis also sets the limits on government spending. It is clear that government spending has to be sufficient to allow taxes to be paid. In addition, net government spending is required to meet the private desire to save (accumulate net financial assets).
From the previous paragraph it is also clear that if the Government doesn’t spend enough to cover taxes and desire to save the manifestation of this deficiency will be unemployment.
This analysis also allows for a further insight that goes to the heart of Jared Bernstein’s concern.
Government spending absorbs real resources that are owned within the non-government sector.
The transfer of the use of these resources from the latter to the government sector allows the government to run its socio-economic mandate (programs).
A government does not really ‘own’ real resources. It has to extract services from the non-government sector.
In doing so it has to deprive the non-government sector of the use of those resources.
Taxation, then, can be seen as the vehicle that a sovereign government uses to ‘free up productive resources’ held in the non-sector, so that it can use them itself.
By depriving the non-government sector of purchasing power, the government creates the ‘fiscal space’ to use the idle real resources for its own purposes.
If you think about that, while taxation has nothing to do with ‘funding’ the government spending, it still allows governments to spend without inflationary consequences.
Once an economy is at (or near) full capacity, then increases in nominal spending growth will be inflationary.
If the government is satisfied with its claim on the available real resources at that point then the current tax revenue is sufficient.
However, if the government wants to increase its relative size in the economy it must reduce the non-government sector’s claim on the available real resources, to avoid inflationary pressures mounting.
That political decision – to increase its relative size – would mean it would have to increase its tax take (at full employment) to provide the extra real resource space to expand its real resource claim.
So in that sense, Jared Bernstein’s idea that revenue has to rise with spending has some coherence.
The full employment fiscal balance
Finally, we can briefly address the issue of the appropriate fiscal balance at full employment. The bottom line is that context is everything.
Governments cannot appraise the appropriateness of a particular fiscal position by looking at financial ratios or comparing one deficit to a past deficit.
As noted above, the most complete account of my treatment of this issue is in this blog – The full employment fiscal deficit condition.
What follows is a brief summary.
The basic point is that there is no necessity for balancing a fiscal position of a currency-issuing government at any point or over any span of an economic cycle.
Many progressives claim that once the economy reaches full capacity, the government has to raise taxes and/or cut spending to ensure a balanced fiscal outcome – or else face inflationary consequences.
This is an argument that so-called ‘deficit doves’ make and it is a position that is representative of the mainstream Post Keynesian position.
There is no question that if nominal spending continues to grow at a rate that outstrips the capacity of the productive sector to meet that spending with real output then firms will move to price-adjustment and inflation will result.
MMT puts that generally accepted observation at front and centre of its analysis.
In part, it helps us to understand the previous discussion over the role of taxes. For there to be real space in the economy for the government to spend, the non-government sector has to be deprived of its capacity to utilise the real resources the government seeks to command.
The – full employment fiscal deficit condition – is a core MMT ‘fiscal rule’ that allows us to appreciate the appropriate fiscal balance at any point in time.
At full employment there is no necessity for the fiscal balance to be zero. Under some conditions, a fiscal surplus might be appropriate. In other situations, which will be more often encountered by nations, continuous fiscal deficits will be required.
In an open economy, if there was no government spending or taxation (so a fiscal 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.
A spending gap is defined as the spending required to create demand sufficient to elicit output levels which at current productivity levels 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.
The role of government fiscal policy is obvious – to ensure no spending gaps persist.
It becomes obvious (and incontestable) that if the non-government spending sources decline from a given position of full employment – due to a preference for more saving (less consumption) or lower levels of capital formation (investment) or higher imports, then the only way that the spending gap can be filled is via a fiscal intervention.
That is direct government spending and/or a tax cut (to increase private disposable income and stimulate subsequent private spending).
What about the maintenance of full employment?
The fiscal position (deficit or surplus) must fill the gap between the savings minus investment minus the gap between exports minus imports (with net income transfers included).
That relationship can be easily satisfied at levels of economic activity that are associated with persistently high levels of unemployment.
Keynes’ General Theory was important in history because it showed how market economies could get stuck in these sort of high unemployment steady-states.
But, to maintain a full employment level of national income, which is generated when all resources are fully utilised according to the preferences of workers and owners of land and capital etc, the fiscal deficit has to be sufficient to offset the saving and imports that occurs at that level of income, less the sum of private capital formation and export revenue that is forthcoming at that level of income.
In simple algebra:
Full-employment fiscal deficit condition: (G – T) = S(Yf) + M(Yf) – I(Yf) – X
Where G is government spending, T is total taxes, M are imports, I is private investment and X is exports.
Yf is the full employment level of income and the sum of the terms S(Yf) and M(Yf) represent drains on aggregate spending when the economy is at full employment and the sum of the terms I(Yf) and X represents spending injections at full employment.
Either way, the point is clear:
If the drains outweigh the injections then for national income to remain stable, there has to be a fiscal deficit (G – T) sufficient to offset that gap in aggregate demand.
If the fiscal deficit is not sufficient, then national income will fall and full employment will be lost.
If the government tries to expand the fiscal 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. It is not a free-for-all. If the goal is full employment and price stability then the Full-employment fiscal deficit condition has to be met.
But also note that the right-hand side of the full-employment fiscal deficit condition will typically not solve out to be zero.
If it did, then at full employment, the appropriate fiscal position would be a balance.
If it solved to a negative outcome, then the appropriate fiscal position at full employment would be a surplus.
But there is nothing necessary for those outcomes to occur and as history tells us, they usually will not happen.
So the spending and saving conditions of the external and private domestic sectors provide the context for appraising the appropriateness of the fiscal outcome at the benchmark of full employment.
This benchmark is what Jared Bernstein terms the “structural” fiscal balance.
At full employment, a continuous fiscal deficit will be likely to satisfy the overall saving desires of the non-government sector. History tells us that.
That continuity of net government spending will not be inflationary because it is filling a spending gap.
It is the normal condition we would expect.
Context is everything.
I hope this three-part series has been of use both to Jared Bernstein (given he asked the questions in the first place) and the broader MMT audience who would like to deepen their knowledge of our approach.
And remember, just as Jared Bernstein noted in his blog – this three-part series is a ‘peaceful’ offering.
There was no martial intent in my three-part response.
So a week after I said I would not write detailed blogs each Wednesday I have written one. But I did say I would do so if it was to maintain continuity in a multi-part blog post. So my ‘Wednesday rule’ is intact :-).
That is enough for today!
(c) Copyright 2018 William Mitchell. All Rights Reserved.