Category Archives: Unemployment

When All Else Has Failed, Why Not Try Job Creation?

Posted on November 15, 2009 by admin | 2 comments

The US continues to hemorrhage jobs even as some purport to see “green shoots”. All plausible projections show that unemployment will rise even if our economy begins to grow. Personally, I think those green shoots will die this winter because the stimulus package is far too small and because the financial system is going to crash again. The longer we wait to actually address the unemployment problem, the worse are the prospects for a real recovery.

In his recent piece, Paul Krugman writes:

Just to be clear, I believe that a large enough conventional stimulus would do the trick. But since that doesn’t seem to be in the cards, we need to talk about cheaper alternatives that address the job problem directly. Should we introduce an employment tax credit, like the one proposed by the Economic Policy Institute? Should we introduce the German- style job-sharing subsidy proposed by the Center for Economic Policy Research? Both are worthy of consideration.

The point is that we need to start doing something more than, and different from, what we’re already doing. And the experience of other countries suggests that it’s time for a policy that explicitly and directly targets job creation.

As Krugman reports, Germany has avoided massive job losses by subsidizing firms that retain workers but reduce hours worked. The EPI’s proposal follows a similar strategy. This is fine so far as it goes—in a sense it allows workers, firms, and government to share the burden of reduced output and thus reduced work hours required. That is more equitable but in my view it is not a path toward recovery. While I do agree with Krugman that greater aggregate demand stimulus is required, there is no reason to believe that would provide a sufficient supply of jobs for all who want to work.

The final sentence in the Krugman post makes far more sense: let’s create MORE jobs, MORE work hours, and MORE payroll. A new, New Deal program with a permanent and universal job guarantee that will supply as many jobs as there are job seekers. Not only will this provide jobs in the New Deal style program, but it will also save jobs and increase work hours in the rest of the economy. Why go for second or third best when the best option is available?

Winston Churchill remarked “The Americans will always do the right thing………. after they`ve exhausted all the alternatives”. Direct job creation is the right way to put the economy onto a sustainable path to recovery.

For discussion and ideas on direct job creation and full employment, go here; here; here; and here.

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Posted in L. Randall Wray, Policy and Reform, Uncategorized, Unemployment

Tagged A Minskian New Deal, L. Randall Wray, Policy and Reform, unemployment

The Time Has Come for Direct Job Creation

Posted on October 23, 2009 by admin | 9 comments

By L. Randall Wray

First Published on the New America Foundation’s blog.

According to an ILO report[15] issued before the global economic crisis hit, even though more people were working than ever before, the number of unemployed was also at an all time high of nearly 200 million. Further, “strong economic growth of the last half decade has only had a slight impact on the reduction of workers who live with their families in poverty…”, in part because the growth was fueling productivity growth (up 26% in the past decade) but was not creating many new jobs (up only 16.6%). The report concluded: “Every region has to face major labour market challenges” and that “young people have more difficulties in labour markets than adults; women do not get the same opportunities as men, the lack of decent work is still high; and the potential a population has to offer is not always used because of a lack of human capital development or a mismatch between the supply and the demand side in labour markets.” All of these statements applied equally well to the United States even at the peak of our business cycle in early 2008.

Now, of course, our labor market is in dire straits–having lost more than 6 million jobs, with official unemployment approaching 10%, and with millions more workers facing reduced hours and even reduced hourly pay. According to a New America Foundation report[16] released late last spring, if we add “marginally attached” workers, those forced to work part-time, and those who would like to work but have given up looking, the effective unemployment total is over 30 million. Add to that another 2 million incarcerated individuals–many of whom might have avoided a life of crime if they had enjoyed better economic opportunities, and it is likely that a more accurate measure of the unemployment rate would be about 20%.

These numbers are similar to those I obtained for the Clinton boom when I estimated how many potential workers remained jobless even when the economy was supposedly at full employment.[17] Labor force participation rates–the percent of working age population that is employed or unemployed–vary considerably by educational level; high school dropouts have very low participation rates, and correspondingly high incarceration rates. I calculated that as many as 26 million more people would be working if we brought labor force participation rates of all adults up to the levels enjoyed by college graduates. That number would be higher now because of lackluster job creation during the Bush years and due to the economic crisis. Thus, we can safely conclude that whether the US economy is booming or busting, it is chronically tens of millions of jobs short.

Comparing such numbers with President Obama’s promise that his policies will create, or at least preserve, three or four million jobs demonstrates that current policy is not up to the task of dealing with our labor market problems. To be sure, there is no single labor market policy that can deal with the scope of our problems. We certainly need to resolve the financial crisis and to restore economic growth. But as experience demonstrates, even relatively robust growth does not automatically create jobs.

We also have severe structural problems: some sectors, such as manufacturing, will create far too few jobs relative to the supply of workers with appropriate skills, while others, such as the FIRE sector–finance, insurance and real estate–likely should be downsized, and still others, such as nursing and trained childcare, face a chronic shortage. Finally, it could be argued that we face another kind of structural problem identified a half century ago by John Kenneth Galbraith: a relatively impoverished public sector and a bloated for-profit sector. Thus, while recognizing the multi-faceted nature of our problem, I believe that direct job creation by government would go a long way toward resolving a large part of–and probably the worst of–our unemployment problem even as it could put people to work to provide needed public sector services.

Direct job creation programs have been common in the US and around the world. Americans immediately think of the various New Deal programs such as the Works Progress Administration (which employed about 8 million), the Civilian Conservation Corps (2.75 million employed), and the National Youth Administration (over 2 million part-time jobs for students). Indeed, there have been calls for revival of jobs programs like VISTA and CETA to help provide employment of new high school and college graduates now facing unemployment due to the crisis.[18]

But what I am advocating is something both broader and permanent: a universal jobs program available through the thick and thin of the business cycle. The federal government would ensure a job offer to anyone ready and willing to work, at the established program compensation level, including wages and benefits package. To make matters simple, the program wage could be set at the current minimum wage level, and then adjusted periodically as the minimum wage is raised. The usual benefits would be provided, including vacation and sick leave, and contributions to Social Security.

Note that the program compensation package would set the minimum standard that other (private and public) employers would have to meet. In this way, public policy would effectively establish the basic wage and benefits permitted in our nation–with benefits enhanced as our capacity to provide them increases. I do not imagine that determining the level of compensation will be easy; however, a public debate that brings into the open matters concerning the minimum living standard our nation should provide to its workers is not only necessary but also would be healthy.

The federal government would not have to micromanage such a program. It would provide the funding for direct job creation, but most of the jobs could be created by state and local government and by not-for-profit organizations. There are several reasons for this, but the most important is that local communities have a better understanding of needs. The New Deal was more centralized, but many of the projects were designed to bring development to rural America: electrification, irrigation, and large construction projects. To be sure, we need infrastructure spending today, but much of that can be undertaken by state and local governments. This program would provide at least some of the labor for these projects, with wages and some materials costs paid by the federal government.

More importantly, today we face a severe shortage of public services that could be substantially relieved through employment at all levels of government plus not-for-profit community service providers. Examples include elder care and childcare, playground supervision, non-hazardous environmental clean-up and caring for public space, and low-tech improvement of energy efficiency of low-income residences. Decentralization promotes targeting of projects to meet community needs–both in terms of the kinds of programs created but also in terms of matching new jobs to the skills of unemployed people in those communities. Also note that by creating millions of decentralized public service jobs, we avoid one of the major criticisms of the stimulus package: because there were not enough “on the shelf” infrastructure-type projects, it is taking a long time to create jobs. Instead, we should allow every community service organization to add paid jobs so that they can quickly expand current operations.

As the economy begins to recover, the private sector (as well as the public sector) will begin to hire again; this will draw workers out of the program. That is a good thing; indeed, one of the major purposes of this program is to keep people working so that a pool of employable labor will be available when a downturn comes to an end. Further, the program should do what it can to upgrade the skills and training of participants, and it will provide a work history for each participant to use to obtain better and higher paying work. Experience and on-the-job training is especially important for those who tend to be left behind no matter how well the economy is doing. The program can provide an alternative path to employment for those who do not go to college and cannot get into private sector apprenticeship programs.

There are some recent real world examples of programs that are similar to the one I am proposing. When Argentina faced a severe financial, economic, and social crisis early this decade, it created the “Jefes” program in which the federal government provided funding for labor and a portion of materials costs for highly decentralized projects, most of which created community service jobs.[19] The program was targeted to poor families with children, allowing each to choose one “head of household” to participate in paid work. The program was up-and-running in a matter of four months, creating jobs for 14% of the labor force–a remarkable achievement. More recently, India has enacted the National Rural Employment Guarantee, which ensures 100 days of paid work to rural adults. While the program is limited, it does make an advance over the Jefes program: access to a job becomes a recognized human right, with the government held responsible for ensuring that right.

Indeed, the United Nations Universal Declaration of Human Rights includes the right to work, not only because it is important in its own right, but also because many of the other economic and social entitlements proclaimed to be human rights cannot be secured without paying jobs. And both history and theory strongly indicate that the only way to secure a right to work is through direct job creation by government. This is not, and should not be, a responsibility of the private sector, which employs workers only on the expectation of selling output at a profit. Even if we could somehow manage economic policy to produce a permanent state of boom, we know that will still leave tens of millions of potential workers unemployed or in part-time and underpaid work. Hence, a direct government job creation program is a necessary component of any strategy of ensuring achievement of many of the internationally recognized human rights.

[15] Global Employment Trends Brief 2007, International Labour Office; results summarized in “Global Unemployment Remains at Historic High Despite Strong Economic Growth”, ILO 25 January 2007, Geneva. See also The Employer of Last Resort Programme: Could it work for developing countries?, L. Randall Wray, Economic and Labour Market Papers, International Labour Office, Geneva, August 2007, No. 2007/5.

[16] Not Out of the Woods: A Report on the Jobless Recovery Underway, New American Contract, New America Foundation, 2009, www.newamericancontract.net.

[17] Can a Rising Tide Raise All Boats? Evidence from the Kennedy-Johnson and Clinton-era expansions, L. Randall Wray, in Jonathan M. Harris and Neva R. Goodwin (editors), New Thinking in Macroeconomics: Social, Institutional and Environmental Perspectives, Northampton, Mass: Edward Elgar, pp. 150-181.

[18] See Not Out of the Woods, referenced above.

[19] See Gender and the job guarantee: The impact of Argentina’s Jefes program on female heads of households, Pavlina Tcherneva and L. Randall Wray, CFEPS Working Paper No. 50, 2005.

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Posted in L. Randall Wray, Policy and Reform, Uncategorized, Unemployment

Tagged Fiscal Policy, L. Randall Wray, Policy and Reform, unemployment

Job Guarantee

Posted on August 23, 2009 by admin | 11 comments

By L. Randal Wray

A job guarantee program is one in which government promises to make a job available to any qualifying individual who is ready and willing to work. Qualifications required of participants could include age range (i.e. teens), gender, family status (i.e. heads of households), family income (i.e. below poverty line), educational attainment (i.e. high school dropouts), residency (i.e. rural), and so on. The most general program would provide a universal job guarantee, sometimes also called an employer of last resort (ELR) program in which government promises to provide a job to anyone legally entitled to work.

Many job guarantee supporters see employment not only as an economic condition but also as a right. Wray and Forstater (2004) justify the right to work as a fundamental prerequisite for social justice in any society in which income from work is an important determinant of access to resources. Harvey (1989) and Burgess and Mitchell (1998) argue for the right to work on the basis that it is a fundamental human (or natural) right. Such treatments find support in modern legal proclamations such as the United Nations Universal Declaration of Human Rights or the US Employment Act of 1946 and the Full Employment Act of 1978. Amartya Sen (1999) supports the right to work on the basis that the economic and social costs of unemployment are staggering with far-reaching consequences beyond the single dimension of a loss of income (see also Rawls 1971). William Vickrey (2004) identified unemployment with “cruel vandalism”,outlining the social and economic inequities of unemployment and devising strategies for its solution. A key proposition of such arguments is that no capitalist society has ever managed to operate at anything approaching true, full, employment on a consistent basis. Further, the burden of joblessness is borne unequally, concentrated among groups that already face other disadvantages: racial and ethnic minorities, immigrants, younger and older individuals, women, people with disabilities, and those with lower educational attainment. For these reasons, government should and must play a role in providing jobs to achieve social justice.

There are different versions of the job guarantee program. Harvey’s (1989) proposal seeks to provide a public sector job to anyone unable to find work, with the pay approximating a ‘market wage,’ whereby more highly skilled workers would receive higher pay. Argentina’s Jefes program (examined below) targets heads of households only and offers a uniform basic payment for what is essentially half-time work. In Hyman Minsky’s (1965) proposal, developed further at The Center for Full Employment and Price Stability, University of Missouri-Kansas City and independently at The Centre of Full Employment and Equity, University of Newcastle, Australia, the federal government provides funding for a job creation program that offers a uniform hourly wage with a package of benefits. (Wray 1998; Burgess and Mitchell 1998) The program could provide for part-time and seasonal work, as well as for other flexible working conditions as desired by the workers. The package of benefits would be subject to congressional approval, but could include health care, childcare, payment of social security taxes, and usual vacations and sick leave. The wage would also be set by congress and fixed until congress approved a rate increase—much as the minimum wage is currently legislated. The perceived advantage of the uniform basic wage is that it would limit competition with other employers as workers could be attracted out of the ELR program by paying a wage slightly above the program wage.

Proponents of a universal job guarantee program operated by the federal government argue that no other means exists to ensure that everyone who wants to work will be able to obtain a job. Benefits include poverty reduction, amelioration of many social ills associated with chronic unemployment (health problems, spousal abuse and family break-up, drug abuse, crime), and enhanced skills due to training on the job. Forstater (1999) has emphasized how ELR can be used to increase economic flexibility and to enhance the environment. The program would improve working conditions in the private sector as employees would have the option of moving into the ELR program. Hence, private sector employers would have to offer a wage and benefit package and working conditions at least as good as those offered by the ELR program. The informal sector would shrink as workers become integrated into formal employment, gaining access to protection provided by labor laws. There would be some reduction of racial or gender discrimination because unfairly treated workers would have the ELR option, however, ELR by itself cannot end discrimination. Still, it has long been recognized that full employment is an important tool in the fight for equality. (Darity 1999) Forstater (1999) has emphasized how ELR can be used to increase economic flexibility and to improve the environment as projects can be directed to mitigate ecological problems.

Finally, some supporters emphasize that an ELR program with a uniform basic wage also helps to promote economic and price stability. ELR will act as an automatic stabilizer as employment in the program grows in recession and shrinks in economic expansion, counteracting private sector employment fluctuations. The federal government budget will become more counter-cyclical because its spending on the ELR program will likewise grow in recession and fall in expansion. Furthermore, the uniform basic wage will reduce both inflationary pressure in a boom and deflationary pressure in a bust. In a boom, private employers can recruit from the ELR pool of workers, paying a mark-up over the ELR wage. The ELR pool acts like a “reserve army” of the employed, dampening wage pressures as private employment grows. In recession, workers down-sized by private employers can work at the ELR wage, which puts a floor to how low wages and income can go.

Critics argue that a job guarantee would be inflationary, using some version of a Phillips Curve approach according to which lower unemployment necessarily means higher inflation. (Sawyer 2003) Some argue that ELR would reduce the incentive to work, raising private sector costs because of increased shirking, since workers would no longer fear job loss. Workers might be emboldened to ask for greater wage increases. Some argue that an ELR program would be so big that it would be impossible to manage; some fear corruption; others argue that it would be impossible to find useful things for ELR workers to do; still others argue that it would be difficult to discipline ELR workers. It has been argued that a national job guarantee would be too expensive, causing the budget deficit to grow on an unsustainable path; and that higher employment would worsen trade deficits. (Aspromourgous 2000; King 2001; See Mitchell and Wray 2005 for responses to all of these critiques.)

There have been many job creation programs implemented around the world, some of which were narrowly targeted while others were broad-based. The 1930s American New Deal contained several moderately inclusive programs including the Civilian Conservation Corp and the Works Progress Administration. Sweden developed broad based employment programs that virtually guaranteed access to jobs, until government began to retrench in the 1970s. (Ginsburg 1983) In the aftermath of its economic crisis that came with the collapse of its currency board, Argentina created Plan Jefes y Jefas that guaranteed a job for poor heads of households. (Tcherneva and Wray 2005) The program successfully created 2 million new jobs that not only provided employment and income for poor families, but also provided needed services and free goods to poor neighborhoods. More recently, India passed the National Rural Employment Guarantee Act (2005) that commits the government to providing employment in a public works project to any adult living in a rural area. The job must be provided within 15 days of registration, and must provide employment for a minimum of 100 days per year. (Hirway 2006) These real world experiments provide fertile ground for testing the claims on both sides of the job guarantee debate.

References

Aspromourgos, T. “Is an Employer-of-Last-Resort Policy Sustainable? A Review Article.” Review of Political Economy 12, no. 2 (2000): 141-155.

Burgess, J. and Mitchell, W.F. (1998), ‘Unemployment Human Rights and Full Employment Policy in Australia,’ in M. Jones and P. Kreisler (eds.), Globalization, Human Rights and Civil Society, Sydney, Australia: Prospect Press.

Darity, William Jr. “Who loses from Unemployment.” Journal of Economic Issues, 33, no. 2 (June 1999): 491.

Forstater, Mathew. “Full Employment and Economic Flexibility” Economic and Labour Relations Review, Volume 11, 1999.

Ginsburg, Helen (1983), Full Employment and Public Policy: The United States and Sweden, Lexington, MA: Lexington Books.

Harvey, P. (1989), Securing the Right to Employment: Social Welfare Policy and the Unemployed in the United States, Princeton, NJ: Princeton University Press.

Hirway, Indira (2006), “Enhancing Livelihood Security through the National Employment Guarantee Act: Toward effective implementation of the Act”, The Levy Economics Institute Working Paper No. 437, January, www.levy.org.

King, J.E. “The Last Resort? Some Critical Reflections on ELR..” Journal of Economic and Social Policy 5, no. 2 (2001): 72-76.

Minsky, H.P. (1965), ‘The Role of Employment Policy,’ in M.S. Gordon (ed.), Poverty in America, San Francisco, CA: Chandler Publishing Company.

Mitchell, W.F. and Wray, L.R. (2005), ‘In Defense of Employer of Last Resort: a response to Malcolm Sawyer,’ Journal of Economic Issues, 39(1), 235-245.

Rawls, J. (1971), Theory of Justice, Cambridge, MA: Harvard University Press.

Sawyer, M. (2003), ‘Employer of last resort: could it deliver full employment and price stability?,’ Journal of Economic Issues, 37(4), 881-908.

Sen, A. (1999), Development as Freedom, New York, NY: Alfred A. Knopf.

Tcherneva, Pavlina and L. Randall Wray (2005), “Gender and the Job Guarantee: The impact of Argentina’s Jefes program on female heads of poor households”, Center for Full Employment and Price Stability Working Paper No. 50, December, www.cfeps.org.

Vickrey, W.S. (2004), Full Employment and Price Stability, M. Forstater and P.R. Tcherneva (eds.), Cheltenham, UK: Edward Elgar.

Wray, L.R. and Forstater, M. (2004), ‘Full Employment and Economic Justice,’ in D. Champlin and J. Knoedler (eds.), The Institutionalist Tradition in labor Economics, Armonk: NY: M.E. Sharpe.

Wray, L.R. (1998), Understanding Modern Money: the key to full employment and price stability, Cheltenham, UK: Edward Elgar.

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Posted in L. Randall Wray, Policy and Reform, Uncategorized, Unemployment

Tagged Fiscal Policy, L. Randall Wray, Policy and Reform, unemployment

Let’s Create a Real Job Czar for the Jobless

Posted on August 20, 2009 by admin | 1 comment

By L. Randal Wray [via CFEPS]

For an example of what can be done, we can look to the recent experience of Argentina. As everyone knows, Argentina had been the darling of the Washington Consensus and of the IMF structural adjustment approach. It opened its economy, freed its markets, privatized government operations, downsized government, adopted fiscal and monetary austerity, and—importantly—adopted a currency board based on the dollar. It did everything “right”, but the IMF/Washington Consensus approach was fundamentally flawed and put Argentina into an inherently unsustainable situation. When world financial markets began to doubt the nation’s ability to maintain the currency board arrangement, there was a run on the domestic currency. The IMF/Washington Consensus recommended more austerity—which caused unemployment and poverty to explode. Social unrest eventually led to rioting in the streets. Argentina wisely abandoned the dollar, floated the currency, defaulted on some of the debt, and rejected the IMF/Washington Consensus.

The rioting stopped when the government implemented a job creation program designed to provide a social safety net for poor households with children. The program evolved through several stages, with the final phase beginning in April 2002 with the implementation of the Jefes de Hogar (Heads of Household) program that provides a payment of 150 pesos per month to a head of household for a minimum of 4 hours of work daily. Participants work in community services and small construction or maintenance activities, or are directed to training programs (including finishing basic education). The household must contain children under age 18, persons with handicaps, or a pregnant woman. Households are generally limited to one participant in the Jefes program.

The program’s total spending is currently equal to about 1% of GDP, with nearly 2 million participants (about 1.7 million in Jefes and 300,000 in PEL). This is out of a population of only 37 million, or more than 5% of the population. However, it should be noted that the US spends 1% of GDP on social assistance, while France and the UK spend 3-4% of GDP on such programs. Given a national poverty rate above 50%, and with 9.6 million indigents and a child poverty rate approaching 75%, Argentina’s spending is small relative to needs.

According to the World Bank’s reviews, the program has been highly successful in achieving a number of goals. First, program spending is well-targeted to the intended population—poor households with children. Second, the program has provided needed services and small infrastructure projects in poor communities, with most projects successfully completed and operating. Third, the program has increased income of poor households. While there have been some problems associated with implementation and supervision of the program cases involving mismanagement or corruption appear to have been relatively rare. Still, there are reports of favoritism, and home country researchers have made serious critiques of program design. However, surveys show that program participants are overwhelmingly happy with the program.

On November 3, 2003, the Mayor of Istanbul, Turkey, announced his intention to create a similar program to fight the growing unemployment problem in that city. Unemployment imposes severe costs on society—both economic costs in terms of foregone output, but also intolerable social costs in terms of rising crime and disintegrating families and communities. The Mayor recognized that no other social program brings so many benefits as those that accompany a job creation program. It will be interesting to follow the developments in Turkey as a “heads of household” job creation program is implemented.

Any sovereign nation that issues its own floating rate currency can “afford” full employment. (Indeed, one might rightly question whether nations can truly “afford” unemployment.) This is because such a government spends by crediting bank accounts, and taxes by debiting them. There can be no question about the solvency of such a nation—even if a deficit results. Japan’s sovereign deficit reaches 8% of GDP; Turkey’s sovereign deficit exceeds 25% of GDP. But so long as these nations maintain floating exchange rates, they can always spend and “service” debt by crediting bank accounts. Hence, if there are unemployed resources, including labor, the sovereign government can put them to work.

The big fear, of course, is that full employment will necessarily generate inflation. If full employment is achieved by “pump priming”, that is, by trying to raise aggregate demand through tax cuts or general government spending, it can in some circumstances generate inflation. However, if full employment is generated through a job creation program designed like Argentina’s Jefes program, it cannot be inflationary. This is because such a program sets a fixed basic wage and then hires all who are ready and willing to work at that wage. This operates like a commodities buffer stock program that sets a floor price—it prevents prices from falling through the floor, but does not push up prices. If the private sector expands, workers are hired out of the labor “buffer stock”; when the private sector down-sizes, workers flow into the “buffer stock”. Hence, the Jefes-type program also provides a strong counter-cyclical stabilizing force. It should be noted that government spending on the program will also be strongly counter-cyclical.

A real Job Czar would be put in charge of a job creation program that would achieve full employment without generating inflationary pressures. Once full employment is achieved, then the pressures to use protectionist measures to fight imports will be diminished. Further, the wage-and-price stabilizing features of a buffer stock approach would reduce reliance on fiscal and monetary austerity to fight inflation.

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Posted in L. Randall Wray, Policy and Reform, Uncategorized, Unemployment

Tagged Hyman P. Minsky, L. Randall Wray, Policy and Reform, unemployment

How to Implement True, Full Employment

Posted on August 12, 2009 by admin | 5 comments

By L. Randall Wray

We will briefly describe a program that would generate true, full employment, price stability, and currency stability. We will show that this program can be adopted in any nation that issues its own currency. Our presentation consists of three sections. First, we briefly examine a pilot program at the University of Missouri—Kansas City (UMKC). This provides the basis for the analysis in the second section of the functioning of a national monetary system. Finally, we show how this knowledge can be used to construct a public service program (PSE) that guarantees true, full employment with price and currency stability.

The Buckaroo Program

In the United States, there is a growing movement on college campuses to increase student involvement in their communities, particularly through what is known as “service-learning” in which students participate in community service activities organized by local community groups. It should become obvious that a modern monetary economy that adopts the full employment program described here will operate much like our community service hours program.

We have chosen to design our program as a “monetary” system, creating paper notes, “buckaroos” (after the UMKC mascot, a kangaroo), with the inscription “this note represents one hour of community service by a UMKC student”, and denominated as “one roo hour”. Each student is required to pay B25 to the UMKC “Treasury” each semester. Approved community service providers (state and local government offices, university offices, public school districts, and not-for-profit agencies) submit bids for student service hours to the Treasury, which “awards” special drawing rights (SDRs) to the providers so long as basic health, safety, and liability standards are met. The providers then draw on their SDRs as needed pay students B1 per hour worked. This is equivalent to “spending” by the UMKC treasury. Students then pay their taxes with buckaroos, retiring Treasury liabilities.

Several implications are immediately obvious. First, the UMKC treasury cannot collect any buckaroo taxes until it has spent some buckaroos. Second, the Treasury cannot collect more buckaroos in payment of taxes than it has previously spent. This means that the “best” the Treasury can hope for is a “balanced budget”. Actually, it is almost certain that the Treasury will run a deficit as some buckaroos are “lost in the wash” or hoarded for future years. While it is possible that the Treasury could run a surplus in future years, this would be limited by the quantity of previously hoarded buckaroos that could be used to pay taxes. Third, and most important, it should be obvious that the Treasury faces no “financial constraints” on its ability to spend buckaroos. Indeed, the quantity of buckaroos provided is “market demand determined”, by the students who desire to work to obtain buckaroos and by the providers who need student labor. Furthermore, it should be obvious that the Treasury’s spending doesn’t depend on its tax receipts. To drive the point home, we can assume that the Treasury always burns every buckaroo received in payment of taxes. In other words, the Treasury does not impose taxes in order to ensure that buckaroos flow into its coffers, but rather to ensure that student labor flows into community service. More generally, the Treasury’s budget balance or imbalance doesn’t provide any useful information to UMKC regarding the program’s success or failure. A Treasury deficit, surplus, or balance provides useless accounting data.

Note that each student has to obtain a sufficient number of buckaroos to meet her tax liability. Obviously, an individual might choose to earn, say, B35 in one semester, holding B10 as a hoard after paying the B25 tax for that semester. The hoards, of course, are by definition equal to the Treasury’s deficit. UMKC has decided to encourage “thrift” by selling interest-earning buckaroo “bonds”, purchased by students with excess buckaroo hoards. This is usually described as government “borrowing”, thought to be necessitated by government deficits. Note however, that the Treasury does not “need” to borrow its own buckaroos in order to deficit spend—no matter how high the deficit, the Treasury can always issue new buckaroos. Indeed, the Treasury can only “borrow” buckaroos that it has already spent, in fact, that it has “deficit spent”. Finally, note that the Treasury can pay any interest rate it wishes, because it does not “need” to “borrow” from students. For this reason, Treasury bonds should be seen as an “interest rate maintenance account” designed to keep the base rate at the Treasury’s target interest rate. Without such an account, the “natural base interest rate” is zero for buckaroo hoards created through deficit spending. Note that no matter how much the Treasury spends the base rate would never rise above zero unless the Treasury offers positive interest rates; in other words, Treasury deficits do not place any pressure on interest rates.

What determines the value of buckaroos? From the perspective of the student, the “cost” of a buckaroo is the hour of labor that must be provided; from the perspective of the community service provider, a buckaroo buys an hour of student labor. So, on average, the buckaroo is worth an hour of labor—more specifically, an hour of average student labor. Note that we can determine the value of the buckaroo without reference to the quantity of buckaroos issued by the Treasury. Whether the Treasury spends a hundred thousand buckaroos a year, or a million a year, the value is determined by what students must do to obtain them.

The Treasury’s deficit each semester is equal to the “extra” demand for buckaroos coming from students; indeed, it is the “extra” demand that determines the size of the Treasury’s deficit. We might call this “net saving” of buckaroos, and it is equal—by definition—to the Treasury’s deficit over the same period. What if the Treasury decided it did not want to run deficits, and so proposed to limit the total number of buckaroos spent in order to balance the budget? In this case, it is almost certain that some students would be unable to meet their tax liability. Unlucky, procrastinating students would find it impossible to find a community service job, thus would find themselves “unemployed” and would be forced to borrow, beg, or steal buckaroos to meet their tax liabilities. Of course, any objective analysis would find the source of the unemployment in the Treasury’s policy, and not in the characteristics of the unemployed. Unemployment at the aggregate level is caused by insufficient Treasury spending.

Some of thisanalysis applies directly to our economic system as it actually operates, while some of it would apply to the operation of our system if it were to adopt a full employment program. Let us examine the operation of a modern money system.

Modern Monetary Systems

In all modern economies, money is a creature of the State. The State defines money as that which it accepts at public pay offices (mainly, in payment of taxes). Taxes create a demand for money, and government spending provides the supply, just as our buckaroo tax creates a demand for buckaroos, while spending by the Treasury provides the supply. The government does not “need” the public’s money in order to spend; rather, the public needs the government’s money in order to pay taxes. This means that the government can buy whatever is for sale in terms of its money merely by providing it.

Because the public will normally wish to hold some extra money, the government will normally have to spend more than it taxes; in other words, the normal requirement is for a government deficit, just as the UMKC Treasury always runs a deficit. Government deficits do not require “borrowing” by the government (bond sales), rather, the government provides bonds to allow the public to hold interest-bearing alternatives to non-interest-bearing government money. Further, markets cannot dictate to government the interest rate it must pay on its debt, rather, the government determines the interest rate it will pay as an alternative to non-interest-earning government money. This stands conventional analysis on its head: fiscal policy is the primary determinant of the quantity of money issued, while monetary policy primarily has to do with maintaining positive interest rates through bond sales—at the interest rate the government chooses.

In summary, governments issue money to buy what they need; they tax to generate a demand for that money; and then they accept the same money in payment of the tax. If a deficit results, that just lets the population hoard some of the money. If the government wants to, it can let the population trade the money for interest earning bonds, but the government never needs to borrow its own money from the public.

This does not mean that the deficit cannot be too big, that is, inflationary; it can also be too small, that is deflationary. When the deficit is too small, unemployment results (just as it results at UMKC when the Treasury’s spending of buckaroos is too small). The fear, of course, is that government deficits might generate inflation before full employment can be reached. In the next section we describe a proposal that can achieve full employment while actually enhancing price stability.

Public Service Employment and Full Employment with Price and Currency Stability

Very generally, the idea behind our proposal is that the national government provides funding for a program that guarantees a job offer for anyone who is ready, willing and able to work. We call this the Public Service Employment program, or PSE. What is the PSE program? What do we want to get out of it?

1. It should offer a job to anyone who is ready, willing and able to work; regardless of race or gender, regardless of education, regardless of work experience; regardless of immigration status; regardless of the performance of the economy. Just listing those conditions makes it clear why private firms cannot possibly offer an infinitely elastic demand for labor. The government must play a role. At a minimum, the national government must provide the wages and benefits for the program, although this does not actually mean that PSE must be a government-run program.

2. We want PSE to hire off the bottom. It is an employment safety net. We do not want it to compete with the private sector or even with non-PSE employment in the public sector. It is not a program that operates by “priming the pump”, that is, by raising aggregate demand. Trying to get to full employment simply by priming the pump with military spending could generate inflation. That is because military Keynesianism hires off the top. But by definition, PSE hires off the bottom; it is a bufferstock policy—and like any bufferstock program, it must stabilize the price of the bufferstock—in this case, wages at the bottom.

3. We want full employment, but with loose labor markets. This is virtually guaranteed if PSE hires off the bottom. With PSE, labor markets are loose because there is always a pool of labor available to be hired out of PSE and into private firms. Right now, loose labor markets can only be maintained by keeping people out of work—the old reserve army of the unemployed approach.

4. We want the PSE compensation package to provide a decent standard of living even as it helps to maintain wage and price stability. We have suggested that the wage ought to be set at $6.25/hr in the USA to start. A package of benefits could include healthcare, childcare, sick leave, vacations, and contributions to Social Security so that years spent in PSE would count toward retirement.

5. We want PSE experience to prepare workers for post-PSE work—whether in the private sector or in government. Thus, PSE workers should learn useful work habits and skills. Training and retraining will be an important component of every PSE job.

6. Finally, we want PSE workers to do something useful. For the U.S.A. we have proposed that they focus on provision of public services, however, a developing nation may have much greater need for public infrastructure; for roads, public utilities, health services, education. PSE workers should do something useful, but they should not do things that are already being done, and especially should not compete with the private sector.

These six features pretty well determine what a PSE program ought to look like. This still leaves a lot of issues to be examined. Who should administer the program? Who should do the hiring and supervision of workers? Who should decide exactly what workers will do? There are different models consistent with this general framework, and different nations might take different approaches. Elsewhere (Wray 1998, 1999) I have discussed the outlines of a program designed specifically for the USA. Very briefly, I suggest that given political realities in the USA, it is best to decentralize the program as much as possible. State and local governments, school districts, and non-profit organizations would be allowed to hire as many PSE workers as they could supervise. The federal government would provide the basic wage and benefit package, while the hiring agencies would provide supervision and capital required by workers (some federal subsidy of these expenses might be allowed). All created jobs would be expected to increase employability of the PSE workers (by providing training, experience, work records); PSE employers would compete for PSE workers, helping to achieve this goal. No PSE employer would be allowed to use PSE workers to substitute for existing employees (representatives of labor should sit on all administrative boards that make hiring decisions). Payments by the federal government would be made directly to PSE workers (using, for example, Social Security numbers) to reduce potential for fraud.

Note that some countries might choose a much higher level of centralization. In other words, program decentralization is dictated purely by pragmatic and political considerations. The only essential feature is that funding must come from the national government, that is, from the issuer of the currency.

Before concluding, let us quickly address some general questions. First, many people wonder about the cost—can we afford full employment? To answer this, we must distinguish between real costs and financial expenditures. Unemployment has a real cost—the output that is lost when some of the labor force is involuntarily unemployed, the burdens placed on workers who must produce output to be consumed by the unemployed, the suffering of the unemployed, and social ills generated by unemployment and poverty. From this perspective, providing jobs for the unemployed will reduce real costs and generate net real benefits for society. Indeed, it is best to argue that society cannot afford unemployment, rather than to suppose that it cannot afford employment!

On the other hand, most people are probably concerned with the financial cost of full employment, or, more specifically, with the impact on the government’s budget. How will the government pay for the program? It will write checks just as it does for any other program. (See Wray 1998.) This is why it is so important to understand how the modern money system works. Any nation that issues its own currency can financially afford to hire the unemployed. A deficit will result only if the population desires to save in the form of government-issued money. In other words, just as in UMKC’s buckaroo program, the size of the deficit will be “market demand” determined by the population’s desired net saving.

Economists usually fear that providing jobs to people who want to work will cause inflation. Thus, it is necessary to explain how our proposed program will actually contribute to wage stability, promoting price stability. The key is that our program is designed to operate like a “buffer stock” program, in which the buffer stock commodity is sold when there is upward pressure on its price, or bought when there are deflationary pressures. Our proposal is to use labor as the buffer stock commodity, and as is the case with any buffer stock commodity, the program will stabilize the commodity’s price. The government’s spending on the program is based on a “fixed price/floating quantity” model, hence, cannot contribute to inflation.

Note that the government’s spending on the full employment program will fluctuate countercyclically. When the private sector reduces spending, it lays-off workers who then flow into the bufferstock pool, working in the full employment program. This automatically increases total government spending, but not prices because the wage paid is fixed. As the quantity of workers hired at the fixed wage rises, this results in a budget deficit. On the other hand, when the private sector expands, it pulls workers out of the bufferstock pool, shrinking government spending and thus reducing deficits. This is a powerful automatic stabilizer that operates to ensure the government’s spending is at just the right level to maintain full employment without generating inflation.

REFERENCES

Wray, L. Randall. 1998. Understanding Modern Money: the key to full employment and price stability, Cheltenham: Edward Elgar.

—–. 1999. “Public Service Employment—Assured Jobs Program: further considerations“, Journal of Economic Issues, Vol. 33, no. 2, pp. 483-490.

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Posted in L. Randall Wray, Monetary policy, Policy and Reform, Taxes, The Federal Government Deficit, The National Debt, Uncategorized, Unemployment

Tagged Fiscal Policy, L. Randall Wray, Monetary policy, Policy and Reform, Taxes, The Federal Government Deficit, The National Debt, unemployment

Leakages and Potential Growth

Posted on August 6, 2009 by admin | 1 comment

By L. Randall Wray

In his book, Leakages, Treval Powers makes the outrageous claim that without leakages, the US economy could grow at a sustained rate of 13% annually. According to his calculations (based on empirical evidence), normal leakages of 7.4% reduce the rate of growth to 5.6%, leaving the economy operating at only 92.6% of its capacity. Periodic restrictive policy by the Federal Reserve adds another layer of leakages, which can reduce growth to zero, causing the economy to operate at only 87% of potential.

Ironically, the Fed imposes tight policy because it wrongly believes that inflationary pressures result from excessive demand, even though the economy chronically operates well below capacity. Indeed, Powers argues that the greater the leakages, the higher the price level, hence, when the Fed tightens it actually puts upward pressure on prices. In his view, the economy has not been supply constrained, at least in the postwar era, so there has been no reason to fight inflation by constraining demand.

All of this goes against the conventional wisdom. Powers might be dismissed as a crank, as someone who simply does not understand economics. While I do find most of his analysis of monetary policy somewhat confusing, I agree with the general conclusions. What I will do in this note is to concur on two main points:

1. the US economy suffers from chronic inadequate demand, and has rarely been subject to any significant supply constraints—whether of productive capacity or of labor;

2. and leakages have been the cause of the demand constraints

Thus, I also agree with the policy conclusions of Powers: Fed policy can be seen as a string of mistakes guided by a fundamentally flawed view that causes the Fed to tighten policy exactly when it should be loosened. Inflation in the US does not result from excessive aggregate demand and, indeed, our worst bouts with inflation have come during periods of above-normal slack.

However, I do not believe that Fed policy normally has a huge impact on the economy, and for that we should be eternally grateful given how misguided it has been. This is the major disagreement I would have with Powers and other critics of the Fed. I could go even further and argue that we really do not know whether restrictive policy by the Fed actually reduces aggregate demand—and whether lower interest rates stimulate demand—but that would take us too far afield.

Fiscal policy is the primary way in which government impacts the economy, and, unfortunately, it has become increasingly misguided in ways that many do not understand—especially during the Bush dynasty era in which populists, leftists, and the Democratic party have wrongly advocated a return to what they call fiscal responsibility. Thus, rather than focusing on monetary policy failings as the cause of demand slack, I highlight the role played by fiscal policy.

Let me begin with my argument that the US economy, as well as the economies of all the other major nations, have suffered from demand constrained growth. Figure 1 compares the per capita inflation-adjusted GDP growth of the major developed nations—indexed to 100 in 1970. Note the relatively rapid growth of Japan.

Per capita (inflation adjusted) GDP growth can be attributed by identity to growth of the employment rate (workers divided by population) plus growth of productivity per worker. Figure 2 shows employment rate growth by nation. Note that only the US and Canada had much growth of the employment rate. The long term trend in these two countries is rising as more women come into the labor force. There are also obvious cyclical trends—especially in Canada—when employment rates can actually fall off due to unemployment. Employment rates actually fell in France on a long-term trend, while they were more or less stable in the other nations.

I attribute the low growth of employment rates to slow growth of aggregate demand; that is, if aggregate demand does not grow at a clip sufficiently above productivity growth, then employment rate growth must (identically) suffer. Indeed, growth in Japan and Europe has not been high enough to increase employment rates—so they have come up with all these schemes to increase vacations, lower retirement ages, and share work (France’s experiment with mandated work week reductions is the most glaring example).

Figure 3 shows productivity growth. Recall that the sum of growth of the employment rate plus growth of productivity equals total per capita GDP growth. Japan, Italy and France had the best productivity growth—these are all nations that had no employment growth. Note that the US is at the bottom here. In the US our employment rate grows fairly strongly (for a number of reasons: population growth, immigration, and women entering the labor force) but given low growth of GDP, our productivity suffers. Figure 4 shows that our growth is just about evenly divided between employment growth and productivity growth.

These two figures shed light on a three-decades long controversy over productivity growth in the US. All during the 1970s and 1980s there was this hysteria about low productivity growth that was supposed to be the cause of low GDP growth. This is a supply side argument and led to all the policy measures, like tax cuts for the rich and other schemes to raise saving, to try to stimulate productivity through induced investment. In fact, the low productivity falls out of an identity; if the US grows at only 3% and if our employment rate grows at 2% it is mathematically impossible for productivity to grow at anything other than 1%.

Figure 5 shows a hypothetical trade-off for the US, Europe and Japan. In other words, for the US to have productivity growth as high as that of Japan or Europe—or as high as we had during the so-called new economy boom under Clinton–we must grow above 4 or 5% per year. This is something we rarely achieve for very long—for reasons I’ll get to in a second. During the Clinton boom there was all this nonsense about information technology that had suddenly made it possible to grow at such rates precisely because productivity was supposed to be able to grow fast. In reality, the fast growth of the Clinton years could have been achieved at any time, if only demand had been that robust.

That brings me to my second main point—the leakages that constrain demand, resulting in chronic underperformance. We can think of the economy as being composed of 3 sectors: a domestic private sector, a government sector, and a foreign sector. If one of these spends more than its income, at least one of the others must spend less than its income because for the economy as a whole, total spending must equal total receipts or income. So while there is no reason why any one sector has to run a balanced budget, the system as a whole must. In practice, the private sector traditionally runs a surplus—spending less than its income. This is how it accumulates net financial wealth. For the US this has averaged about 2-3% of GDP, but it does vary considerably over the cycle. That is a leakage that must be matched by an injection.

Before Reagan we essentially had a balanced foreign sector—we ran trade surpluses or deficits, but they were small. After Reagan, we ran growing trade deficits, so that today they run about 5% of GDP. That is another leakage.

Finally, our government sector taken as a whole almost always runs a budget deficit. This has reached to around 5% under Reagan and both Bushes. That is the injection that offsets the private and foreign sector leakages. With a traditional private sector surplus of 3% and a more or less balanced trade account, the “normal” budget deficit needed to be about 3% during the early Reagan years. In robust expansions, before the Clinton years, the domestic private sector occasionally ran small and short lived deficits—an injection that allowed a trade deficit to open up, and reduced the government budget deficit. See Figure 6.

Until the Clinton expansion, the private deficits never exceeded about 1% of GDP and never lasted more than 18 months. However, since 1996 the private sector has been in deficit every year, and that deficit climbed to more than 6% of GDP at the peak of the boom. This actually drove the budget into surplus of about 2.5% of GDP. With the trade deficit at about 4% of GDP, the private sector deficit was the sum of those—almost 6.5%. While everyone thought the Clinton budget surplus was a great achievement, they never realized that by identity it meant that the private sector had to spend more than its income, so that rather than accumulating financial wealth it was running up debt.

Let me link this back to the leakages discussed by Powers. The trade deficit represents a leakage of demand from the US economy to foreign production. There is nothing necessarily bad about this, so long as we have another source of demand for US output, such as a federal budget that is biased to run an equal and offsetting deficit. Private sector net saving (that is, running a surplus) is also a leakage. As discussed above, that was typically 2-3% in the past. If we add in the trade deficit that we have today (5% of GDP), that gives us a total “normal” leakage out of aggregate demand of 7 or 8%–about equal to the estimates of Powers.

This leakage has to be made up by an injection from the third sector, the government. The only way to sustain a leakage of 7-8% is for the overall government to run a deficit of that size. Since state and local governments have to balance their budgets, and on average actually run surpluses, it is up to the federal government to run deficits. The federal budget deficit is largely non-discretionary over a business cycle, and at least over the shorter run we can take the trade balance as also outside the scope of policy.

The driving force of the cycle, then, is the private sector leakages. When the private sector has a strong desire to save, it tries to reduce its spending below its income. Domestic firms cut production, and imports might fall too. The economy cycles downward into a recession as demand falls and unemployment rises. Tax revenues fall and some kinds of social spending (such as unemployment compensation) rise. The budget deficit increases more-or-less automatically. That is where we are today, with Bush budget deficits rising to 5% of GDP and, soon, beyond. They will probably need to reach 8% before we get a sustained recovery.

In sum, we experienced something highly unusual during the Clinton expansion because the private sector was willing to spend far more than its income; the normal private sector leakages turned into very large injections. The economy grew quickly and tax revenues literally exploded. State governments and the federal government experienced record surpluses. These surpluses represented a leakage that brought the expansion to a relatively sudden halt. What we have now is a federal budget that is biased to run surpluses except when growth is very far below potential. This means is that the “normal” private sector balance now must be a large deficit in order for the economy to grow robustly.

Rather than the government sector being a source of injections that allow the leakages that represent private sector savings, we now have the private sector dissaving in order to allow the foreign and government sector leakages. This sets up a highly unstable situation because private debt ratios rise quickly and a greater percentage of income goes to service those debts. While I said at the beginning that Fed policy normally doesn’t matter much, in a highly indebted economy, rising interest rates can increase debt problems very quickly—setting off bankruptcies that can snowball into a 1930s-style debt deflation. A far more sensible policy would be to reverse course and lower interest rates, then keep them low.

At the same time, the federal government should take advantage of slack demand and abundant labor by increasing its spending on domestic programs. Robust economic growth fueled by federal deficits is the best way to reduce over-indebtedness. It is hard to say what to do (if anything) about euphoric stock or real estate markets that could be stoked by renewed growth. But the Fed’s sledgehammer approach of jacking up interest rates does not work. We will probably need selective credit controls to constrain financial speculation, if such is desired.

In conclusion, I agree with Powers that growth in the postwar period has mostly been demand constrained, due to leakages. If demand were to grow at 7% or even 10% on a sustained basis, I see no reason to believe that supply could not keep pace. This is all the more true in today’s global economy with massive quantities of underutilized resources all over the world, and with the rest of the world desires to accumulate dollar-denominated financial assets. This requires that they sell output to the US—which is just the counterpart to our trade deficit leakage. In real terms, a trade deficit means we can enjoy higher living standards without placing pressure on our own nation’s productive capacity. While it is hard to project maximum sustainable growth rates, there can be little doubt that our economy chronically operates far below feasible rates. The best policy would be to push up demand, allow growth rates to rise, and try to test those frontiers.

Reference:

Treval C. Powers, Leakage: The bleeding of the American economy, Benchmark Publications, Inc, New Canaan, Connecticut, 1996.

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Posted in L. Randall Wray, The Federal Government Deficit, Uncategorized, Unemployment

Tagged Fiscal Policy, Government's IOU, L. Randall Wray, The Federal Government Deficit, unemployment

Another Great Depression?

Posted on July 20, 2009 by admin | Comments Off

By Felipe Rezende

In a previous post, I explained that automatic stabilizers- i.e. the fact that the federal government’s budget moves counter-cyclically and in an automatic fashion – imparts a great stabilizing force to aggregate demand.
However, the picture below shows that, during the Great Depression the government sector was too small relatively to the rest of the economy.

Source: Tymoigne, 2008: 12

The implementation of New Deal policies created automatic stabilizers which work by putting a floor under aggregate demand, preventing a deflationary spiral, but they also put ceilings in place, as rapid economic growth translates into rising tax revenues which destroy income and temper the expansion.
Nowadays, the size of the government and the impact of large automatic stabilizers explain why we can have a deep recession but another Great Depression is unlikely.
But how do automatic stabilizers work? What happens over the cycle? Hyman Minsky sheds light on these issues.

Minsky’s financial instability hypothesis can be described as follows. Let us consider that the whole U.S. economy is in a hedge position, i.e. that cash inflows are greater than outflows for every period, so that debt/payment commitments can be fulfilled while safety margin are kept at some positive level, for instance 20%. As firms and households become more optimistic about future earnings, and as their expectations get validated by economy growth, they change their behavior and reduce their margins of safety, let’s say now to 10%.

As the economy booms, and future earnings turn out to be more than expected, firms and households revise their expectations upwards, they begin to believe they were too pessimistic in the past and, therefore, reduce their cushions of safety, and start to take on more and more riskier projects. They have voluntarily moved into a position Minsky called speculative. A speculative position is one in which cash inflows are enough to meet interest payments, i.e. as they cannot repay the principal they need to refinance the outstanding debt. Borrowers start to discount risk and lenders, now more optimistic about prospective future earnings and profits, increase their willingness to lend.

It is now important to introduce how the level of investment is determined according to Minsky’s framework. Firms invest if the demand price of capital exceeds the supply price of current output. “The quantity of investment goods purchased (OId) is determined where PId = PIs” (Tymoigne and Wray 2008, p.9)

The demand price, Pk, is the price that firms are willing to pay for the capital asset. The demand price depends upon the cash flows that ownership is expected to yield and the liquidity of the asset. The curve is horizontal up to the point where firms only commit their internal funds. However, once firms rely on external financing then the subjective borrower’s risk comes into play. This risk is incurred by firms as they may not be able to service their debt. Thus, the price that firms are willing to pay for capital assets decline as the amount they have to borrow to finance it increases.

The supply price, Pi, is the price that firms actually have to pay for the capital good. Firms can use their internal funds up to Oif , and only up to this point, the supply price equals costs + markup. When firms have to borrow to buy capital goods, the supply price of investment is raised by the interest payments on the loan. The curve slopes up after the point Oif because of the lender’s risk. The lender’s risk is the risk the firm will not repay the loan. The more the individual firm borrows, the greater the lender’s risk associated and the higher the interest rate charged on the loan.

When lenders and borrowers become more optimistic about future earnings and profits, they start to discount risks. Firms take on riskier projects and financial institutions riskier loans. Thus, the belief is now that future income will be enough to cover debt commitments. They are in a speculative position.

If there is a change in the economic environment firms’ financial positions may be adversely impacted. Let’s consider the following situation where the economy accelerates and inflation becomes a concern to the monetary authority. The turning point would happen when the Fed decides to increase the overnight interest rate. If the interest rate specified on contracts is allowed to fluctuate, firms incur in higher financial costs to service the loan. At the new circumstance, firms can either abandon the project, as it is no longer profitable at higher interest rates, or they can borrow, from willing financial institutions, the funds they need to meet the interest payments on the previous loans. In other words, if interest rates are increased to such a point where firms’ income inflows are no longer sufficient to meet the firms’ outflows, they have involuntarily moved into a new financial position that Minksy called Ponzi. In a Ponzi scheme, firms have to capitalize interest. If financial institutions become worried about the future performance of the economy as a whole or the firm in particular, and decide to no longer extend those Ponzi loans, then firms are no longer capable of meeting their financial commitments and may default on their loans. This situation can be compounded as firms decide to sell their assets at fire sale prices in order to meet their obligations, setting in a Fisher-type debt deflation process which triggers a domino effect on the economy.

Another situation we could consider as a turning point is one in which firms’ expectations about future earnings/profits is not fulfilled. In such an environment, firms will revise their expectations downwards and cut investment. As we know, this will have a multiplier effect in the economy. As income is reduced, so is consumption. Firms cut back production and investment, which depresses incomes further. The economic activity spirals down squeezing incomes even more. As firms’ income inflows were significantly reduced, firms may get to a point where they can no longer meet their liability commitments. Once again, a debt-deflation process may be set in place by the new economic environment when firms decide to sell their assets at fire sale prices trying to meet their obligations.

Now, we may ask ourselves: what is the role of automatic stabilizers in this process?
The answer becomes even clearer. With big government automatic stabilizers are large enough to offset the swings in private spending. As explained in a previous post, when the economy goes into recession, unemployment rises which means that income transfers such as unemployment compensation and welfare are automatically increased.

According to Minsky, there are 3 major effects derived from automatic stabilizers: the income and employment effect, the cash flow effect, and the portfolio effect. Let me briefly explain each one:

The income effect is the traditional Keynesian multiplier. As the economy slows down, the government deficit increases as there is an automatic increase in spending and a reduction of the amount of taxes collected. As noted in previous posts (here and here), a sovereign government spends by crediting bank accounts which means that the banking system, all else equal, now has excess reserves (ERs). The ERs put a downward pressure on the fed funds rate. If the Fed is to hit its overnight nominal interest rate target, it has to intervene and conduct open market sales (OMS) to drain the ERs. As the Fed provides an interest bearing alternative – such as government securities – this is adds to the private sector’s income.
Therefore, transfer payments and interest payments automatically increase when the economy is moving into a recession.

The other one is the cash flow effect. The idea is that government deficits maintain the flow of profits. Following Kalecki (1972) and national accounting identities, in the simplest version, aggregate profits equal investment plus the government’s deficit, Π = Invest. + Gov. Deficit. In the expanded model, gross profits, after corporate tax, equals investment plus government fiscal deficit plus consumption out of profits plus net exports less saving out of wages, i.e. Π = Invest. + Gov. Deficit + CC + NX– SW. This means that government deficits add to profits (private wealth). The flow of profits prevents the collapse of expectations and the deterioration of private sector’s balance sheet.

Finally, the portfolio effect is generated by the increase in the sale of government bonds as a consequence of the (mostly automatic) increased government deficit (as I have just explained). These bonds are safe assets and their holdings on private sector’s balance sheets help to keep expectations from collapsing below a certain level.

The Big Bank (the Fed) act as a lender of last resort, it can prevent or minimize the fall in asset prices. In other words, the Fed can always put a floor to asset prices. This can be done in many ways, such as by calling up banks and say that they need to lend to investors who want to buy assets. The Fed can also decide to buy a wide range of private assets to smooth market transactions. If the Fed decides to buy a wide range of assets to provide liquidity to markets it smoothes liquidity concerns of market participants. It can also regulate markets and discourage bad loans such as subprime real state booms in some regions so that banks will not provide those loans. However, ceilings should also be put in place such as supervision and regulation, as has been emphasized by William K. Black.

In the current recession, the forecast is that the personal saving rate will reach something like 10% in 2009 and that it could jump to 14-16% by 2010. To meet the private sector rising saving desire the government should implement another stimulus package (in the context of the Krugman’s cross described here, this would be equivalent to a shift of the government sector balance -GSB- curve to the right) thus preventing a deflationary spiral and further declines of income due to rising private sector saving desire. At the same time, it becomes important to adopt policies that make the curve steeper by enhancing the role of automatic stabilizers. One possibility is an employer of last resort program in which the federal government provides a job to everyone willing and able to work at a given nominal wage. As argued in previous posts(here and here) such program would reduce both unemployment and poverty and minimize declines in the economic activity by enhancing the ceilings and floors of the system.

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Posted in Felipe C. Rezende, Uncategorized, Unemployment

Tagged Felipe C. Rezende, Fiscal Policy, Hyman P. Minsky, unemployment

A Third Stimulus Package and Job Creation

Posted on July 20, 2009 by admin | 3 comments

Our own L. Randall Wray and Lawrence Mishel say that additional stimulus is needed to create jobs immediately.

http://www.reuters.com/resources/flash/include_video.swf?edition=US&videoId=108026

Read more here, here, here, and here.

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Posted in L. Randall Wray, Policy and Reform, Uncategorized, Unemployment

Tagged Fiscal Policy, L. Randall Wray, Policy and Reform, unemployment

Time For the Third Stimulus Package

Posted on July 9, 2009 by admin | 4 comments

by L. Randall Wray

According to Paul Krugman “voices calling for stronger stimulus are, may I say, sorta kinda respectable — several Nobelists in the bunch, plus a large fraction of the prominent economists who predicted the housing crash before it happened.”

Professor Krugman provides a link to those who argued that the second stimulus was too small, as well as to those who are already calling for a third stimulus. Three UMKC-affiliated professors are listed, including yours truly. With some immodesty, I’d like to point out that Wynne Godley and I were already calling for a stimulus package in 1999. We were worried that a tightening fiscal stance forced our economy to rely on unsustainable private sector deficits. We said:

“Growing government budget surpluses combined with growing trade deficits have generated record private sector deficits. Unless households continue to reduce their saving—creating an increasingly unsustainable debt burden—the impetus that has driven the expansion will evaporate.”

Of course the economy did quickly collapse into recession, but emerged due to restoration of a budget deficit plus a growing domestic private sector deficit. Over the years, many of us continued to warn that the budget remained too tight while private sector deficits were unsustainable. It all went on far longer than we expected, which does not prove us wrong but rather means that the slump will be immensely worse than it would have been had it come to an end earlier. That is why many of us believe the stimulus is orders of magnitude too small. The private sector is left with a monumental debt overhang and things will not get better until private balance sheets recover.

The best thing that the government can do now is to stop the job losses and to start creating jobs. We are not talking about a couple of million new jobs at this point—we need 6.5 million to replace those already lost, plus another 1-2 million to provide jobs for those who would have entered the labor force (high school and college graduates, for example) if the economy had not collapsed. Reports this morning show that President Obama’s approval rating is falling—below 50% in the swing state of Ohio—and job loss is a big part of the reason. Pessimism is setting in and it will be hard to overcome because it is well-founded. Job losses are devastating for communities—retailers are hit, real estate prices continue to fall, and state and local governments are forced to cut spending.

Many are looking back to 1937, when fiscal policy inappropriately tightened and threw the economy back into depression; indeed the collapse in 1937 was faster than the original crash that started the Great Depression off. To some extent that is not the correct analogy because most of the second stimulus package has yet to be spent, and recent data reported by Mike Norman shows that the federal deficit has actually increased in recent days. But it is still not enough, as evidenced by the growing economic stress around the country.

I realize that it is important for Congress to settle on some dollar figures for a third stimulus because that is the way that budgeting works. But in truth it is impossible to say beforehand how much we will need to stop the carnage. As James Galbraith has been warning, it is better to err on the upside. So far we have done the opposite—with the predictable result that the economy continues on a path toward another great depression.

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Posted in L. Randall Wray, Policy and Reform, The Federal Government Deficit, Uncategorized, Unemployment

Tagged A Minskian New Deal, Fiscal Policy, L. Randall Wray, Policy and Reform, The Federal Government Deficit, unemployment

The Carnage Continues: Time To Ramp Up the Stimulus

Posted on July 7, 2009 by admin | 5 comments

By L. Randall Wray

Some like to see green shoots everywhere, but that is becoming an increasingly audacious hope. Here are four related stories from the July 5th edition of the New York Times:

Tax Bill Appeals Take Rising Toll on Governments By JACK HEALY

Homeowners across the country are challenging their property tax bills in droves as the value of their homes drop, threatening local governments with another big drain on their budgets…. The tax appeals and reassessments present a new budget nightmare for governments. In a survey conducted by the National Association of Counties, 76 percent of large counties said that falling property tax revenue was significantly affecting their budgets…. Officials in some states say their property tax revenue is falling for the first time since World War II.

Safety Net Is Fraying for the Very Poor By ERIK ECKHOLM

Government “safety net” programs like Social Security and food stamps have pulled growing numbers of Americans out of poverty since the mid-1990s. But even before the current recession, these programs were providing less help to the most desperately poor, mainly nonworking families with children… The recession is expected to raise poverty rates, economists agree, although the impact is being softened by the federal stimulus package adopted this year…. “It’s a good thing we have the stimulus package,” Mr. {Arloc} Sherman said. “But what happens to the most vulnerable families in two years, when most of the provisions expire?”

Employment Report Sours the Market By JEFF SOMMER

A grim report on unemployment on Thursday let the air out of the stock market…. In a monthly report, the Labor Department said that 467,000 jobs were lost in June. In surveys, most economists expected 100,000 fewer jobs lost. The unemployment rate edged up to 9.5 percent from 9.4 percent the previous month, to its highest level in 26 years, and virtually all analysts expect joblessness to mount in the coming months.

So Many Foreclosures, So Little Logic By GRETCHEN MORGENSON

LAST week, the stock market tumbled on news that housing foreclosures and delinquencies rose again in the first quarter. The Office of the Comptroller of the Currency said that among the 34 million loans it tracks, foreclosures in progress rose 22 percent, to 844,389. That figure was 73 percent higher than in the same period last year…. But the most fascinating, and frightening, figures in the data detail how much money is lost when foreclosed homes are sold. In June, the data show almost 32,000 liquidation sales; the average loss on those was 64.7 percent of the original loan balance.

What do these reports have in common? They provide powerful evidence that the federal government is not doing enough to help the “real” economy. As Sam Gompers famously responded when asked what workers wanted–“More!”—our nation’s state and local governments, households, workers, and poor need more help, now. We have tried the Reagan/Paulson/Rubin/Geithner “trickle down” approach of targeting relief to Wall Street, but the only thing trickling down is misery. The only way to stop the downward spiral is to substitute trickle-up policy—and even if nothing trickles-up, at least we will have helped those most in need.

I have already outlined a comprehensive recovery package so will here simply summarize four policies that would bring immediate relief.

1. Payroll tax holiday: This provides nearly $2500 of tax relief per year for each worker, with the same amount of relief going to that worker’s employer. The total stimulus to the economy would be somewhere around $650 billion per year. The relief is well-targeted (to workers and employers), immediate (take home pay rises as soon as the holiday takes effect), simple to administrate, and can be phased out (if desired) after the economy recovers.

2. State and local government assistance: The current stimulus package provided some relief to state and local governments, but was so little that it is forcing them to make Hobson’s choices: cut poor children from Medicaid roles or decimate universities? Furloughs for firefighters or postpone bridge repairs? Increase real estate taxes or raise fees for services? Only the federal government can resolve revenue shortfalls by providing funding to keep state and local governments running. Perhaps $400 billion, allocated by population (a bit over $1200 per capita) across state and local governments would be sufficient. If President Obama really could reform healthcare, that would generate tremendous savings for state governments that are saddled with exploding Medicaid costs to cover low income and elderly patients. Until then, direct grants are required. As I have argued, for the long-term we need a permanent program of federal transfers to states, with some of that attached to a requirement that they reduce reliance on regressive taxes.

3. Jobs to reduce poverty: Last week Pavlina Tcherneva provided an excellent argument for direct job creation by the federal government. We have already lost 6 million jobs, and Tcherneva notes that unemployed plus discouraged workers total about twice that number. However, a plausible case can be made that we are short more than 20 million jobs—as Marc Andre Pigeon and I demonstrated a decade ago. Further, as Stephanie Kelton and I showed, a substantial amount of America’s poverty problem is really a jobless problem. We found that in 2002 the poverty rate of families with no member working reached nearly 26%; on the other hand, if the family had at least one member working full-time, the poverty rate fell to just 3.5%. Our conclusions were similar to those offered by Hyman Minsky: “The achievement and sustaining of tight full employment could do almost all of the job of eliminating poverty” (1968, p. 329); “a large portion of those living in poverty and an even larger portion of those living close to poverty do so because of the meager income they receive from work” (p. 328). Minsky believed that “a suggestion of real merit is that the government become an employer of last resort” (1968, p. 338). Thus, not only will direct job creation reverse the trend toward ever-higher unemployment rates, but it will also go a long way toward filling the growing holes in the social safety net.

4. Homeowner relief: The plan offered by Warren Mosler provides an alternative to the current painful foreclosure process. When banks begin to foreclose, the government would step in to purchase the property at the lower of market price or outstanding mortgage balance. Of course, establishing market price in a glut is not simple and I will leave it to real estate market experts to compose a plan. What is more important is to keep people in their homes. Mosler proposes that the federal government would rent homes back to the dispossessed owners (Dean Baker has a similar plan) for a specified period (perhaps two years) at fair market rent. At the end of that period, the government would sell the home, with the occupant having the right of first refusal to buy it. By itself, this proposal would do little to stop spiraling delinquencies and foreclosures, and home prices will probably continue to decline for many months (or even years). However, as the other parts of this stimulus package begin to spur recovery, the real estate sector freefall will (eventually) be halted. I am somewhat ambivalent about continued falling house prices—on one hand, this will make housing more affordable; on the other it is devastating for families. Still, reducing evictions by offering a rental alternative will help reduce the pain of foreclosure. It might also allow the process to speed up (with smaller losses for banks) since many families would choose to stay-on as renters, with the possibility that they could later buy their homes at more reasonable prices.

I will not address here the preposterous argument that failure of the economy to swiftly recover is evidence against the Keynesian belief that government spending is the answer. Leaving to the side the Wall Street bail-outs (that do little to stimulate production and jobs), only a small portion of the stimulus package has been spent to date. There is evidence, however, that the automatic stabilizers (falling federal tax revenue and rising federal spending) are doing some good already—and would eventually pull the economy out of this depression. However, there is no reason to wait for our ship to hit bottom before it slowly resurfaces. Active, discretionary, targeted policy can reduce suffering and generate the forces that will be required to overcome substantial headwinds created by the private sector as well as by our state and local governments. Only the federal government has the fiscal wherewithal to lead us out.