About fifty million people throughout history have tumbled the fact that there are an infinite number of public sector type jobs that the unemployed could to: sweeping the streets, maintaining public parks, etc.
These advocates of having government act as employer of last resort (ELR) nearly always advocate PUBLIC SECTOR type work, rather than PRIVATE SECTOR type work. And there is an appealing logic here, namely that the output of the public sector is GIVEN AWAY rather than SOLD. Thus demand does not need to be raised to create said public sector type jobs. (At least that is presumably the logic employed: the logic is rarely spelled out.)
That would seem to mean that there cannot be any inflationary effect from said public sector jobs. Unfortunately there is a flaw in that argument, as follows.
If unemployment is above NAIRU, or the “natural level” or the “inflation barrier” level, as Bill Mitchell calls it, a straight rise in demand is far preferable to any sort of ELR job. So let’s concentrate on the scenario where ELR really comes into its own, that is where unemployment is at or below NAIRU.
If an ELR scheme involves just the ex-unemployed and no other factors of production like permanent skilled labour, capital equipment or materials, it will be hopelessly inefficient. On the other hand, the scheme CANNOT order up the latter “other factors of production” (OFP) from the regular economy, because if the economy is at NAIRU, no extra demand is permissible.
So ELR is in a bind. At least it is certainly in a bind if it takes the form of schemes which consist of new or “specially set up” employers, as was the case with WPA – the main “make work” scheme in the U.S. in the 1930s.
Alternatively, an ELR scheme CAN consist of allocating the unemployed to jobs with EXISTING public sector employers (as was the case with the Comprehensive Employment and Training Act (CETA) system in the 1970s). But there is a problem here, which is that public sector employers are under similar cost cutting and output maximising incentives as the private sector. That is, if a public sector employer can cut costs by hiring subsidised ELR people and have them replace staff that the employer actually has to pay for, then the employer will be tempted to do so. Indeed, this abuse occurred to some extent under CETA.
Thus it is necessary to have rules in place governing the system (as indeed was the case with CETA). And those rules need to ensure as far as possible, that those taken on under ELR would not have been hired but for ELR. Of course the latter objective can never be attained with perfection, but as long as the objective is more or less hit, then the benefits of ELR will hopefully outweigh the costs.
Now if the above rules ensure that public sector employers are induced to expand output by taking on ELR people (rather than order up more of that inflationary OFP) then presumably the same rules applied to private sector employers will have the same result: that is private sector employers, if offered ELR employees on the same conditions as they are available to public sector employers, will expand output (given an increase in demand) by taking on ELR people rather than by ordering up more of that inflationary OFP.
Ergo there is no reason to confine ELR to the public sector.
QED.
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Warning: this post is a bit technical, semantic and arcane.
Vítor Constâncio, vice-president of the ECB makes the following claim:
“Central bank reserves are held by banks and are not part of money held by the non-financial sector, hence not, per se, an inflationary type of liquidity. There is no acceptable theory linking in a necessary way the monetary base created by central banks to inflation.” (Hat tip to Mike Norman.)
I have no quarrel with Constâncio’s attack on the idea that boosting bank reserves boosts bank lending, which is the basic point he makes here. But I don’t fully agree with the above quote from C’s speech.
When bank reserves rise by $X, the amount deposited in commercial banks will most likely rise by the same amount, all else equal. To illustrate, suppose $Y of my govt bonds are QE’d. I get a cheque for $Y from the central bank. I deposit the cheque at my commercial bank, and the latter deposits the cheque at the central bank. Net result: bank reserves rise by $Y and deposits at commercial banks rise by $Y.
The only exception would be where the govt bonds QE’d are bonds owned by some commercial bank.
The result of the above “$Y” operation is that private sector net financial assets do not rise, but they DO BECOME more liquid. In addition, having a central bank buy govt bonds is the classic way of enforcing an interest rate reduction, and it is generally agreed that interest rate reductions are stimulatory, (and if the stimulus goes too far, inflationary.) So, contrary to C’s claims, there certainly are transmission mechanisms via which a rise in reserves could be inflationary.
That can all be put another way – sort of – as follows. The only reason that (quoting C) “central bank reserves are not part of money held by the non-financial sector” is that very few private sector entities are allowed to have accounts at central banks: that is, most private sector entities have to employ commercial banks as agents when those entities come by some central bank money (as in the case of QE). But that is a feeble argument for saying that private sector non-bank entities don’t hold or possess central bank money.
So how should C have phrased the above quoted two sentences? I think he should just have said something like “An increase in bank reserves as such does not encourage extra bank lending”. And that’s it. In trying to broaden the point too much and include ideas about “no acceptable theory linking in a necessary way the monetary base created by central banks to inflation” he tripped up.
He should have me as his speech writer – then he’d REALLY trip up.
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As unemployment declines, the suitability of each succeeding person hired for vacancies also declines. That is because the fewer the unemployed, the less the likelihood of finding someone suited to any given vacancy.
In other words, as unemployment declines the marginal product of labour also declines.
When “suitability” declines to the point where the output of those hired does not cover the minimum wage / union wage / going wage, etc etc, employers tend to resort to consciously or unconsciously poaching each other’s staff. The result is that the price of labour is bid upwards, and inflation kicks in.
The latter problem could be ameliorated by inducing employers to take on relatively unsuitable staff with the assistance of a subsidy.
As to how to identify the “unsuitable”, that is not too difficult. Just let employers claim the subsidy in respect of any employee/s they like, but for a limited period. On expiration of the subsidy for any specific individual, if the employee is GENUINELY unsuitable, the employer will be happy to let them go. In contrast, if the allegedly unsuitable employee is in fact relatively productive, the employer will keep the employee and will be bluffed into paying the full wage.
There are numerous ways employers could game that system, but its not too difficult to think of anti-gaming rules to counteract the gaming.
P.S. 15th Feb. More discussion of the above idea here.
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Internet discussion about having government act as employer of last resort (ELR) has flared up in the last week amongst advocates of Modern Monetary Theory. So I thought I’d set out a brief summary of a paper by an opponent of ELR: Malcolm Sawyer (Prof of economics at Leeds University in the UK).
His paper is 14,000 words, so some people might prefer something a bit shorter: the summary below is about a tenth as long. This summary is bound to be inaccurate in some respects. Don’t expect perfection on this blog.
The headings below are the actual headings used in Sawyer’s paper. After each point, I’ve put a brief comment of my own.
Functional Finance and ELR.
i) The value of output from ELR jobs is inherently low, because given full employment, a range of “normal” or regular jobs would exist which are regarded as being more worthwhile than ELR jobs. I.e. given full employment a proportion of (or all ELR) jobs are abandoned, and the relevant labour moves to regular employment.
My answer to that is: “OK, but ELR jobs are still arguably better than nothing.”
ii) Sawyer then divides unemployment up into the usual categories, frictional, structural and demand deficient. Plus he makes the conventional point that where demand deficient unemployment is at a minimum (or if you like, at “NAIRU”), frictional and structural factors are the obstacle to further unemployment reduction. That is, employers cannot find the skill mix they want.
This means that if ELR is used to deal with unemployment when unemployment is a NAIRU, then ELR has a skill mix problem.
My answer to that: “True. That’s one reason I advocate offering the unemployed temporary subsidised places with EXISTING employers, rather than ELR.” See here.
Finance and Money.
i) Sawyer sets out one of the basic ELR claims that used to be put by advocates of Modern Monetary Theory (though they’ve gone quite on this point in recent years.) This is that the costs of ELR can be funded essentially by printing money, and then controlling inflation by the sale of government bonds. But as Sawyer rightly points out, the money printing idea leads to a never ending expansion in the amount of “money plus bonds” relative to GDP, which is unsustainable.
ii) Sawyer’s next point, to quote, is “…why restrict the form of government expenditure in this way?” In other words if employment can be expanded simply by printing money, why not print money and use such money to create extra regular or normal jobs?
My answer: “Good point. In other words, the whole idea that money printing can fund ELR is nonsense, as advocates of Modern Monetary Theory now seem to have conceded.”
Costs of ELR proposals.
i) Under this heading Sawyer points out that some estimates of the cost of ELR include just the cost of labour! He claims that the costs of materials, capital equipment and permanent skilled labour are likely to double the costs.
My answer: “Good point.”
ii) Sawyer then gives another reason for costs being underestimated, namely that ELR would actually draw people into the labour force.
My answer: “What of it? This involves employing those who have given up looking for work, and are thus not classified as “unemployed”. There is nothing wrong with employing members of this “hidden unemployed” category.”
Are the Jobs Available?
i) Sawyer claims that ELR jobs need to be jobs which “do not require much skill or which use skills which are widely available in the population (e.g. literacy, ability to drive). Second, the job leads to the production of useful output, but the output is not necessary in that the output is only forthcoming when aggregate demand is low and the ELR jobs are required. Even work on capital projects (which has often been used to provide jobs at times of high unemployment) would not fit the ELR requirements. Apart from logistical problems of speeding up or slowing down capital projects depending on the state of aggregate demand, much of the work on capital projects is skilled work for which wages are usually significantly above the minimum wage. Jobs such as those in education, health service, personal social services, and care would not be good candidates for ELR jobs. Such jobs may well provide valuable public services and could be expanded as part of mainline public expenditure. But they do not provide examples of jobs which can be undertaken at the basic wage and only undertaken when there is a low level of demand in the economy, generating requirements for ELR jobs.”
My answer: “Good point.”
ii) Sawyers says, “ELR jobs have to be provided virtually instantaneously, for if they are not then someone requiring an ELR job would be unemployed (in reality if not in name). If the capital equipment, material inputs, and supervisory labour for a job are not immediately forthcoming (or standing idly by), then this job cannot be "switched on" to meet ELR job requirements.” And having capital equipment and skilled labour “standing idly by” is a waste of resources.
My answer: “Good point. That’s one reason temporary subsidised jobs with existing employers are better than ELR: the capital equipment (and skilled labour) is already there.”
iii) Next, Sawyer says “an ELR job which did draw on material inputs to a significant degree would generate demand (for those materials) in the non-ELR sector.”
My answer: “Quite right. And that’s one flaw in the claim that ELR is non-inflationary. Or put another way, to create ELR jobs with any sort of respectable output, materials and capital equipment have to be withdrawn from the regular economy. The advocates of ELR never quantify this destruction of regular employment when computing the output of ELR jobs: they just sweep this problem under the carpet.”
iv) Next, Sawyer points to the fact that unemployment can be particularly high in particular geographical areas, or suddenly rise in such areas because of the closure of a local large employer. As he points out, while there may be an argument for having a SMALL proportion of the population doing ELR type work over the country as a whole, having a LARGE proportion doing same in high unemployment areas would tend to result in pointless types of work.
My answer: “Valid point.”
ELR, Underemployment, and Unemployment.
i) Sawyer claims that if the wage on ELR type work exceeds the value of the output on such work, then the relevant employees are making a “net claim” on the rest of the economy.
My answer: “Not a good criticism. The alternative is to have the relevant people unemployed, in which case their “net claim” is probably LARGER!”
ii) Training. In the para starting “To illustrate the significance of these figures…” Sawyer gets the point (not appreciated by many ERL enthusiasts) that there is clash between on the one hand the relatively fast turnover of the unemployed and presumably equally fast turnover of ELR employees, and on the other hand, the requirement that any half decent training on ELR schemes has to last for a considerable or specific period. That is, money spent on a training course that pupils abandon half way thru, is money that is largely wasted.
This deficiency has been substantiated by empirical studies done around Europe over the last twenty years which shows that straightforward subsidised work produces better results than training on ELR schemes.
iii) Next, Sawyer points to the fact that ELR employees have to be available at a moment’s notice for mainstream jobs, which would lead to inefficiencies on ELR projects.
My answer: “True, but that is not a desperately strong criticism since peripheral or relatively unskilled employees in mainstream employment also tend to leave at a moment’s notice.”
ELR, the NAIRU, and Inflation.
i) Where ELR is voluntary, its attractions for those partaking must be superior to the attractions of unemployment. Ergo the RELATIVE attractions of regular employment are reduced. To this extent, NAIRU under ELR (sometimes called NAIBER) will be higher than in the absence of ELR.
My answer: “Correct. I tumbled to this point decades ago as did the Swedish labour market economist, Calmfors, who entitled the effect “Calmfor’s Iron Law of Active Labour Market Policy. The only way round this problem is to introduce what might be called a “workfare” element into ELR: i.e. “do this job else your unemployment benefit gets cut”.
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Roll of drums, fanfare, etc. It’s just been announced that the Vickers proposals on banking are to be implemented in the UK. And everyone thinks that safe banking activities will be separated from unsafe activities. Well people believe whatever they’re told, I suppose.
Vickers actually puts both risky and non-risky activities inside the much vaunted “ring-fence”, when the whole object of the exercise is to separate the two.
For example, it is generally thought that money deposited in banks by small depositors like you and me should be 100% safe (though that idea is flawed, as I’ll explain below). So these deposits are inside the fence. But so too are loans to small and medium size enterprises: clearly not an entirely safe activity! But it gets worse. The report is not even clear on whether deposits from and loans to large companies should be inside or outside the fence. (1st paragraph on p.12).
Or as Jill Treanor, the Guardian’s City editor put it, “The commission is vague about whether banking to large companies should be in or outside the ring-fence.”
If Vickers & Co could not make up their mind on that basic and simple point, why did they even publish their report?
Loans and equity: how different are they?
As regards separating so called investment banking from other bank activities, there is another problem, which is that the line between “investing” in a company and “lending” to a company is very blurred. To illustrate, a loan which is last in line for reimbursement in the event of bankruptcy and/or where the so called interest is related to profits is very close to “investing” i.e. taking an equity stake. Lawyers will have a field day here.
So it’s no surprise that there is an article on the Legal Recruitment site entitled, “Vickers review puts lawyers centre stage”.
Or as Martin Jacomb, former chancellor of the University of Buckingham put it in the Financial Times, “The ring-fencing proposal involves much detailed regulation.”
Why did Vickers get in this muddle?
Why, if the object of the exercise is to separate the safe and risky, does Vickers mix them up inside their famous ring fence? The explanation lies in a piece of economics which the Vickers & Co clearly did not grasp. And this revolves round what they call “trapped deposits” (e.g. see p.277). I’ll explain.
Deposits, or at least some of them, need to be safe. At the same time, lending out money is clearly not 100% safe. Thus there is an absolutely fundamental conflict between safe deposits and lending.
If one solves this problem with excessive restrictions on the types of loan that banks can make with “safe deposit money”, the relevant money is liable to become what Vickers calls “trapped”. And this, according to Vickers, would reduce the supply of credit (paragraph A3.29).
Well obviously it WOULD reduce the supply of credit, all else equal. But (and this is the point that Vickers does not get) if restrictions are put on the way money can be used, there is nothing to stop a central bank / government expanding the money supply to compensate for this.
Indeed, central banks have massively increased the supply of central bank created money (monetary base) in response to the crunch. Perhaps Vickers & Co weren’t aware of this.
But that all raises a question, namely what is the point of expanding the money supply and then putting restrictions on how money can be used? Answer is that it enables us to get a clear distinction between money that is supposed to be 100% safe and money which the possessor of said money wants to have invested, and which in consequence is not 100% safe: exactly what Vickers & Co aim to do but fail to do.
Or in the words of Mervyn King, “If there is a need for genuinely safe deposits, the only way they can be provided . . . is to insist such deposits do not coexist with risky assets”.
Quite right. I.e. what we need is a system under which those who deposit money in banks have a choice. If they want 100% safety, that’s fine: but they cannot at the same time reap the benefits of having their money invested in a less than 100% safe manner. That involves a free lunch, and someone somewhere pays for that free lunch: cross subsidisation is involved.
Alternatively, if depositors want their bank to lend out their money, nothing wrong there. The money is being put to good use, so depositors can get a decent rate of interest. But they cannot at the same time ask for 100% safety. And since their money has been locked up in some business or a mortgage, they cannot ask for instant access to their money either.
We have a choice. Face reality, which will dispense with cross-subsidisation. Or second, we can live in la-la land where we indulge in the belief that we can have our cake and eat it. But the result is cross-subsidisation.
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Peter Schiff, the well known loudmouth tries to refute the idea behind Paul Krugman’s baby sitting co-op article. (Hat tip to Stefan Karlsson.)
Schiff begins with about twenty or thirty insults before getting to the crux of the argument. That together with Schiff’s loud and excitable voice makes me suspect that Schiff’s real skill is getting drunk and picking fights with fellow drinkers, rather than economics.
Schiff then claims the babysitting coop failed because too many coupons were issued: complete nonsense! At least there is nothing in Krugman’s article about the co-op failing for this reason. (Although the average mentally retarded six year old has doubtless worked out that if excess amounts of money/coupons are issued, there will be a problem, i.e. inflation.)
Schiff then claims that a fundamental flaw in the baby sitting co-op is that baby-sitting hours are priced the same regardless of whether it’s a weekday, weekend, New Year’s Day, etc etc. Perhaps Schiff or anyone else can explain why this “same price regardless” system applies to millions of products in every economy round the world, and without any big problems.
Of course “price discrimination” as economists call it, and as is explained in introductory economics text books, makes sense and is profitable for vendors as long as the administration costs are not too high. But this discrimination is not essential for an economy to function.
The one area where Schiff is half right is his claim that escaping recessions that result from bubbles simply by printing money will lead (if history is any guide) to another bubble sooner or later. Problem with that argument is that most of the human race have worked that one out, and no thanks to Schiff: that’s why we are busy tightening up bank regulations! Doh!
To spell that out in detail for the benefit of people with Schiff’s non-existent knowledge of economics, it was excessive and irresponsible borrowing that contributed to (or were the basic cause of) the credit crunch. Hence the need for tighter bank regulation.
But then it is precisely right wingers, like Schiff who tend to oppose more regulation, and left wingers like Krugman who tend to back tighter regulation.
The irony will be way above the head of Schiff the loudmouth.
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Correction, 18th Dec: Krugman’s Slate article DID SAY that the co-op issued too many tokens, but DIDN’T SAY that the co-op collapsed for this reason.
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This might sound bizarre, but there are numerous so called professional economists who don’t understand that central banks can print money.
To be more exact, these economists, if asked “Can central banks print money?” would probably answer “Yes”. But they then proceed to write articles based on the assumption that central banks CANNOT print money. It’s weird. (I’ll deal with their articles in detail below.)
Indeed, Modern Monetary Theory (MMT) is little more than an attempt to push the above point, namely that given excess unemployment, it’s a good idea for a government / central bank machine to print money and spend it. As Abba Lerner, arguably the founding father of MMT rightly pointed out, “Fundamentally the new theory, like almost every important discovery, is extremely simple. Indeed it is this simplicity which makes the public suspect it as too slick......What progress the theory has made so far has been achieved not by simplifying it but by dressing it up to make it more complicated and accompanying the presentation with impressive but irrelevant statistics.”
Quite. In addition to the “public”, universities are full of academics who won’t believe anything unless a hundred words are used where one will do. Those academics don’t like simple solutions to problems: that might put them out of work. And their own job security takes precedence over reducing unemployment or reducing poverty.
Article No 1: Financial Times leader.
This leading article in the FT argues that Britain’s debt ought to be reduced, or at least the rate of increase slowed down. And the reason given is old shibboleth that doing so impresses “investors” (3rd para) and enables Britain to borrow at relatively low rates.
As regards borrowing and spending for stimulus purposes what's the problem if "investors" don't want to lend? Whence the assumption that a monetarily sovereign country needs to borrow when it can perfectly well print money? See what I mean? The article assumes it is not possible to print.
As Keynes and Milton Friedman pointed out, a deficit can be funded EITHER by borrowed OR printed money.
And as regards the structural deficit/debt, much the same applies: that is a monetarily sovereign country can just print its way out of trouble. Of course the printing could prove too inflationary, but that’s no problem: all that is needed is some sort of DEFLATIONARY measure, like increased taxation, to counter the inflationary effect. Net effect: zero. That is, the debt comes down, while demand and employment remain unaffected.
2. Jeffrey Sachs.
At the end of the second paragraph of this article by Sachs, he claims, “Keynesian thinking presumes that the financial markets will readily buy government bonds to finance the stimulus.” Complete bo**ocks! Keynes made it perfectly clear that deficits can be funded EITHER BY BORROWED OR PRINTED MONEY!!!!!
Re Keynes, see 2nd half of 5th paragraph here.
And Sachs was the youngest ever “Professor of Economics” at Harvard. Apparently studying economics is not a requirement for the latter post.
3. Willem Buiter.
In this article, Buiter makes the bizarre claim that “The U.S. like every country that has independent monetary authority, when it has an unsustainable fiscal situation, has two options. One is default, right, and the other . . . . is inflation.
Bo**ocks again! There is a third option: just stop borrowing and go for whatever combination of 1, increased tax / reduced public spending, and 2, printing is suitable.
Buiter is actually half aware of the fact that central banks can print when he says, “Permanent monetisation of the vast deficits anticipated in the US and the UK would be highly inflationary.” Well of course! But that’s just a man of straw argument. It takes the print idea to an absurd extreme.
In contrast, the above mentioned COMBINATION of printing and tax increases would not, if implemented in a competent manner, cause excess inflation.
4. Jared Bernstein.
In this article, Bernstein claims, “As I’ve stressed throughout, debt is not just important—it is an essential tool of economic growth.”
NO IT IS NOT. Friedman set out a monetary system in which there is NO GOVERNMENT DEBT AT ALL!!!!!!! Warren Mosler advocates a similar system.
Re Friedman, see paragraph starting “Under the proposal…” (p.250) here.
Bernstein sits on the Congressional Budget Office's advisory committee, but as far as I can see from the summary of his career on Wiki, he has never studied economics. As I said above, a knowledge of economics does not seem to be an essential requirement when appointing people to jobs where you’d think a knowledge of the subject is essential. And the poor and unemployed pay a heavy price for this.
Bernstein incidentally also trots out the old myth that if government makes worthwhile investments, that justifies the borrowing needed to fund such investment. Bo**ocks again. Bernstein needs to read a paper by Kersten Kellermann on this subject.
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Afterthought – 17th Dec. Re the final paragraph above, perhaps I should have added that the most fundamental reason that any entity borrows to make an investment is that it does not have the necessary cash available. E.g. if you want a £15k car and have well over £15k in the bank it probably won’t make sense for you to borrow £15k.
And governments have an almost limitless source of cash available: the taxpayer. Thus the most basic reason for borrowing to make an investment does not make sense in the case of governments. But of course there are other relevant points to consider, as Kellermann explains.
Afterthought (22nd Dec). There is another example of the “central banks can’t print” thinking in an article by Robert J. Samuelson in the Washington Post.
Samuelson is not a professional economist, but he is influential all the same. He claims in his article that “Standard Keynesian remedies for downturns — spend more and tax less — presume the willingness of bond markets to finance the resulting deficits at reasonable interest rates.”
Afterthought, 6th March, 2012. Here is another example of a “Prof.” claiming that government must either borrow or tax in order to spend. It’s John Cochrane, professor at the University of Chicago Booth School of Business.
See paragraph starting “But where did the money come from?
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