Modern Monetary Theory – what is new about it? – Part 2 (long)

In yesterday’s Part 1 of this two-part blog – Modern Monetary Theory – what is new about it? – I introduced the idea that a major new contribution of Modern Monetary Theory (MMT) to economic theory was in its treatment of inflation and the Phillips curve. This is part of a keynote presentation I will be giving at the International Post Keynesian Conference – which will be held at the University of Missouri – Kansas City between September 15-18, 2016. The keynote presentation is scheduled for Friday, September 16 at 17:00. The topic of my keynote presentation will ‘What is new about MMT?’ and will challenge several critics from both the neo-liberal mainstream and from within the Post Keynesian family that, indeed, there is nothing new about MMT – they knew it all along! I contest that when they say this they are lying and doing so to cover up the inadequacies of their own failed analytical frameworks whether they be mainstream or Post Keynesian.

The Phillips curve issue is important because, arguably, it was the failure of ‘Keynesian’ economists in the 1970s to respond to the Monetarist inflation and unemployment mythology after the OPEC oil crises, that opened the door for what we now think of as ‘free market’ thinking (or pre-Great Depression neo-classical) mainstream in macroeconomics and its modern perversions, such as New Keynesian economics with its bizarre and futile DSGE modelling mantra, to dominate current economics teaching and policy making.

Alan Coddington (1983) provided an excellent introduction to the different views that parade under the banner of ‘Keynesian’.

The major unifying theme stems from Keynes’ challenge of the neo-classical thought that dominated until the Great Depression. Keynes clearly considered that government intervention was necessary to ensure that under-full employment stalemates didn’t arise – due to lack of aggregate spending. The idea that you could have a steady-state situation with mass unemployment was anathema to neo-classical thought, which paraded models that essentially always assumed full employment.

Any unemployment was voluntary and an expression of a preference for leisure in the neo-classical scheme. Coddington characterised this line of thinking as “reductionist” – the body of thought being constructed from a priori theorising about individual maximisation and choice.

The consideration that what applies to an individual will apply to all individuals left the mainstream approach of the day open to the criticism that its failed to understand the importance of the fallacy of composition

Coddington then divided the development of “Keynesian” thinking into three different camps: (a) the fundamentalists (Davidson); (b) the hydraulics (IS-LM analysis – the neo-classical synthesis); and (c) the reconstituted reductionists (Clower, Leijonhufvud etc).

The ‘hydraulics’ emerged in the Post World War II period as policy makers tried to come to terms with the messages of Keynes and text-book writers started to encapsulate it (simplify) it for students.

The emergence of this line of thinking really started in the General Theory itself when in Chapter 2, Keynes left the door open for the neo-classical school to reassert itself through his use of the marginal productivity theory of labour demand, which was straight mainstream and wrong to boot.

Soon after the General Theory was published the mainstream set about tinkering with the body of idea and what emerged has been also called the neo-classical synthesis.

The so-called IS-LM macroeconomic model them emerged, which simplified Keynes’ ideas to the point of futility (being a static model with no role for expectations etc).

The hydraulics dominated the debate in the 1950s and 1960s and while retaining a role for discretionary government counter-stabilisation policies introduced all the nonsense about crowding out and debt crises.

The static framework did away with the ideas that behavioural relationships (consumption, investment, demand for money etc) were subject to endemic uncertainty and instead assumed they were stable.

The ‘hydraulics’ also were enamoured with formal representations (mathematical expressions) of the so-called ‘Keynesian’ model and students were led to believe that this was science with all behavioural functions assumed to be stable and appropriate for policy analysis and simulation.

A hydraulic relationship between spending, income and output (and employment) was assumed – increase policy lever X and Y happens – push spending and the rest change in predictable ways.

This obsession with formal modelling, despite the fact that economists, parading as hard scientists, used relatively inferior mathematical tools and even defied the conventions from differential calculus by placing the independent variable (price) on the y-axis and quantity on the x-axis (another story), became a benchmark for good and bad analysis.

The likes of Palley and Wren-Lewis (see introduction) seem to still believe that to be the case!

I remind readers of the observation by American (Marxist) economist Paul Sweezy who wrote in the 1972 – Monthly Review Press – article entitled Towards a Critique of Economics that orthodoxy (mainstream) economics:

… remained within the same fundamental limits … of the C19th century free market economist … they had … therefore tended … to yield diminishing returns. It has concerned itself with smaller and decreasingly significant questions … To compensate for this trivialisation of content, it has paid increasing attention to elaborating and refining its techniques. The consequence is that today we often find a truly stupefying gap between the questions posed and the techniques employed to answer them.

Mathematics is just a language – one of many. Sometimes it helps to sort out problems that other languages cannot solve. Usually that is not the case, especially is a social science like economics.

The use of formality is only justified if it simplifies what cannot be easily said in words. Otherwise, it just perpetuates the idea that economics is just a cult of the cognoscenti who have learned a few elementary rules of pure mathematics.

The idea that fiscal deficits had to be balanced over some cycle (however hard it might be to define that temporal span) emerged as doctrine under the dominance of the hydraulics.

The so-called deficit doves, which includes some Post Keynesians, are comfortable using deficit spending to increase economic activity under some circumstances, couch their recommendations in conservative logic bounded by appropriate movements in the debt to GDP ratio. As long as the ratio is stable there is no problem.

Paul Krugman has popularised this view. For example, in his New York Times column (November 3, 2009) – On not listening – he wrote (Krugman, 2009a) that:

… fiscal stimulus is necessary only under certain special conditions. Namely, when you’re up against the zero lower bound, and conventional monetary policy is useless, fiscal stimulus may be your best option.

At the heart of their concerns is a particular view of the Phillips curve.

The Phillips orthodoxy in the 1960s was in the tradition of Keynes and saw price adjustment as a response to disequilibrium arising from the labour market (excess labour supply).

Unemployment in this sense was usually considered to be involuntary and the product of inadequate spending.

So it was strictly a framework where disequilibrium in the real sector (unemployment) caused changes in nominal aggregates (wages and prices).

During the hydraulic Phillips curve period (1950s to late 1960s) policy makers considered there was a trade-off between inflation and unemployment.

So the cost of lower unemployment was some inflation. The aim was to get the lowest rates of each consistent with the expectations of voters. In general, nations enjoyed full or close to full employment during this period.

The emergence of Milton Friedman’ famous 1968 article and Phelps’s two articles in 1967 and 1968, respectively was an expression of the growing neo-classical discontent with the lack of optimising microfoundations (rationality, maximisation etc) in the hydraulic Keynesian macroeconomics.

Remember, that before Keynes there was no macroeconomics as we know it today. The aggregate economy was just thought of a series of individual microeconomic relations ‘added up’, notwithstanding the invalidity of the representative agent fudges that were used to accomplish that task.

But the Monetarists reasserted neoclassical microfoundations and were then left to explain why Say’s Law (that demand would always adjust to supply) did not work all the time.

To overcome that problem Friedman and Phelps and their coterie followed Irving Fisher and identified misperceptions of inflation as the factor that prevented Say’s Law from working according to the market-clearing model.

In other words, when prices rose faster than money wages (hence real wages fell), firms would employ more workers. But why would workers supply more labour at lower real wages (which was contrary to the mainstream model)? Because they thought the money wages were rising and hadn’t observed the inflation.

As soon as they found at the truth, so Phelps argued, they would withdraw their labour supply and employment would drop again.

So the business cycle was characterised as swings in labour supply around the point where households maximised their utilisty with respect to work and leisure.

These ideas persisted, partly because they were disguised as science through the use of highly stylised mathematical models that commanded authority among sycophantic graduate students, who then went out in the field and spread the religion.

So, the Monetarists in the late 1960s channelled Irving Fisher’s ideas from the 1920s and reversed the hydraulic Keynesian causality – price changes in equilibrium drove real changes.

This was a highly significant shift in thinking and went relatively uncontested by the ‘Keynesians’, who were diverted into arguments about whether a particular coefficient in an equation was equal to 1 or not.

The concept of full employment – where there had to be enough jobs to match the preferences of the labour force lost meaning with the development of the so-calledExpectations-Augmented Phillips Curve of Friedman and Phelps.

This model spearheaded the resurgence of pre-Keynesian macroeconomic thinking in the form of Monetarism.

The embedded Natural Rate Hypothesis (NRH) outlined a natural rate of unemployment (NRU), where the inflation-unemployment tradeoff was allegedly a trade-off between unemployment and unexpected inflation. The NRU is now popularly called the NAIRU (although the two concepts are slightly different).

As workers gained more information the trade-off vanishes. At this point there is only one unemployment rate consistent with stable inflation – the NRU. So in the so-called long-run there was no stable trade-off between inflation and unemployment.

These developments represented a major theoretical break from the previous versions of the Phillips curve. The pre-Monetarist Phillips curve models were based on a disequilibrium notion of the relationship between inflation and unemployment in that they modelled the adjustment of prices and wages to some labour market imbalance between supply and demand.

The causality was strictly from the labour market disequilibrium to the price adjustment function. There was no presumption that full employment is inevitable or a tendency of a capitalist monetary economy.

The Friedman-Phelps story and the later developments under the rubric of rational expectations and the New Classical School are, instead, based on a market clearing relation and the causality is reversed.

Unemployment is considered to be voluntary and the outcome of optimising choices by individuals between work (bad) and leisure (good). In the natural rate world of Friedman and Phelps, the Central Bank can promote variations in the unemployment rate by introducing unforeseen changes in inflation, a temporary capacity allowed due to expectational inertia on behalf of the workers.

There is no theory in the natural rate hypothesis that changes in the unemployment rate cause changes in inflation.

Full employment is assumed to prevail (with unemployment at the natural rate) unless there are errors in interpreting price signals. The tendency is always to restore full employment by market mechanisms. There is no discretionary role for aggregate demand management by government.

The rise in acceptance of Monetarism and its new classical counterpart was not based on an empirical rejection of the Keynesian orthodoxy. It was just an argument based on highly abstract a priori theorising and reasserted the conservative ideology at the expense of liberal thinking.

It was not, in a word, a Kuhnian scientific revolution.

However, the shift in the Phillips curve in the 1970s as the OECD economies began to fail was a strong empirical endorsement for the NRU theory, despite the fact that the instability came from the cost side (OPEC oil price hikes) rather than excessive spending.

Any ‘Keynesian’ remedies proposed to reduce unemployment were met with derision from the bulk of the profession who had embraced the NRH and its policy implications.

The NRH was now the characterisation of full employment and it was asserted that the economy would always tend back to a given NRU, no matter what had happened to the economy over the course of time. Time and the path the economy traced through time were thus irrelevant. Only microeconomic changes would cause the NRU to change.

So Phelps’s work in developing the natural rate hypothesis allowed the conservative profession to reassert Say’s Law again and undermine active use of fiscal policy. It set the agenda that has been developed during the neo-liberal years.

Needless to say that these ideas began to dominate central banking and treasury circles, as the surrender by the British Labour Party while in government in 1974-79, testifies.

Remember the claim by Prime Minister James Callaghan that (made at the 1976 Labour Party National Conference):

We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step.

Robert Skidelsky (2009) concluded that this marked the line in the sand that ended the ‘Keynesian’ era.

Accordingly, the policy debate became increasingly concentrated on deregulation, privatisation, and reductions in the provisions of the Welfare State.

The Marxists

While the mainstream ‘Keynesians’ appeared somewhat lost in the early 1970s, the main challenge to the Monetarists interpretation of the inflation that emerged at that time, came from Marxist economists.

Even though Post Keynesians now incorporate the so-called ‘conflict theory of inflation’ into their analysis, the motivation for the theory did not come from Keynes at all.

The long post World War 2 boom was coming to an end by end of the 1960s. The collapse of the Bretton Woods system in August 1971 marked the end of the fixed exchange rate system for most nations and the tensions that had built up in the 1960s over income distributional intensified.

The trade unions had become strong and were becoming more militant as they sought to improve the material conditions of their membership. Membership was high and the later shifts in industry composition towards services and labour force composition towards increased female participation had not yet eroded their capacity to recruit new entrants.

The unions were just behaving according to their institutional logic as part of the conflictual class relations in Capitalism.

On the other side, the growing concentration of industry and the rise of the big multi-national firms had entrenched capital’s power more tightly.

The upshot of this rising institutional power and organisation on both sides of the labour bargain was that workers were increasingly able to push for better pay and firms were increasingly able to push for higher profit margins – and each could resist the attempts of the other to improve their relative position at the expense of the other.

The role of the State in this period of post World War 2 development is also important to understand. While most governments were clearly committed to maintaining full employment through the use of their fiscal capacities, they also didn’t want unseemly breakouts of industrial unrest.

In that context, governments were also willing to deliberately allow inflation to mediate between capital and labour and prevent damaging periods of industrial unrest.

As Robert Rowthorn noted (1980: 139):

[governments] … have been unable or unwilling to intervene on a scale sufficient to resolve the basic contradictions of capitalist development, and yet they have been unwilling to face the consequences of potentially very serious crisis. Where imbalances have arisen which threatened to squeeze profits and provoke a crisis, governments have used their control over expenditure to maintain demand. This has created relatively buoyant demand conditions and allowed firms to raise prices, and thereby maintain or even increase the rate of profit …

As a rule, demand is not been maintained specifically to allow firms to increase their prices, but in response to some other pressures, such as the need to maintain full employment or provide cheap finance for industry. On the other hand, when firms have made use of favourable demand conditions in order to raise their prices, governments have not usually prevented them from doing so …

So, it is clearly being governed policy to allow higher prices, and to this extent we can say that inflation is deliberate policy designed to foster the accumulation of capital by maintaining or even raising the rate of profit.

John Cornwall (1989: 100) used the term “inflationary bias” to describe the situation where the real income resistance on both sides of the labour market had created the conditions where “no successful incomes policy can be implemented that would allow involuntary unemployment to be reduced to a minimum without the strong demand conditions leading to accelerating rates of inflation”.

He considered this ‘bias’ forced governments to introduce aggregate spending policies “that are restrictive enough to generate high rates of unemployment” (p.100). We will come back to that discussion presently.

However, it was the Marxists in the early 1970s who brought these distributional conflicts to the fore by arguing that the emerging high inflation was a structural construct of Capitalism (see Devine, 1974).

Devine said that the increased bargaining power of workers (that accompanied the long period of full employment in the Post Second World War period) and the declining productivity in the early 1970s imparted a structural bias towards inflation which manifested in the inflation breakout in the mid-1970s which “ended the golden age”.

This argument implicated Keynesian-style approaches to full employment by suggesting that the emphasis on high employment and high rates of growth provided the conditions for these biases to emerge.

Then with the collapse of the Bretton Woods system of convertible currencies and fixed exchange rates (which provided deflationary forces to economies that had strongly domestic demand growth) these structural biases came to the fore.

Further, the ‘hydraulic’ Keynesian view was tha inflation would only result if aggregate spending outstripped the capacity of the firms to produce goods and services, leaving them no option but to increase prices – the so-called demand-pull concept.

Accordingly, high unemployment should be associated with low inflation and vice versa.

So for economists operating in this tradition, stagflation (the simultaneous incidence of high inflationa and unemployment) which prevailed after the OPEC oil shocks, presented a new situation and a major quandary. They understood that unemployment could be easily prevented through demand-side stimulus, that is, more spending.

But they also thought that inflation was the result of too much spending – “too much money chasing too few goods”.

So how could policy deal with stagflation?

It wasn’t as if the distributional issues had not been considered before by non-Marxist economists.

There were economists in the post Second World War period who understood that inflation could also emerge as a result of sudden cost pressures (for example, imported oil price rises) which then squeezed existing profit margins and the real value of the workers’ wages, and under certain circumstances, could trigger a struggle between labour and capital over who would bear this loss.

Inflation would result if workers gained wage rises and firms responded by pushing up prices or vice versa. The correct policy response was to address the incompatible demands for more national income from labour and capital by seeking some sort of consensual approach to sharing the costs of the imported raw material price rise.

Arthur Joseph Brown, an English economist, who in 1955 published his major work The Great Inflation, 1939-51, well before the 1958 Phillips curve publication in Economica, provided a wonderful explication of the way in which struggles between labour and capital over the distribution of national income could result in inflation.

Brown was firmly in the Keynesian mould and he sought to understand and explain the underlying causes of inflation and said that to characterise the process as a (1955: 16):

… propensity of the community to spend more than its current income … does not throw much light upon the causes of inflation …

In other words, he sought to challenge the ‘hydraulic’ Keynesian consensus about demand-pull inflation.

Brown saw the changes in real income shares as being a crucial determinant of inflation and that the motives for demanding “wages increases and price increases are connected to distribution” (p.104) and that the “aims of the two parties who are competing for the real income of the country or their success in achieving those aims” (p.105) defines the wage-price spiral.

In other words, the inflation process results from incompatible claims on total nominal income by workers, and firms, which exceed the total available.

Workers negotiate real wage targets via money wage demands on firms, who in turn pursue some target markup (as a vehicle for a desired rate of return). Prices may be slow to adjust in a time of rising costs due to the costs of price adjustment.

If the sum of the claims exceeds national income, either or both parties may use their price-setting power to achieve their targets. Inflation is the outcome of the distributional conflict.

Brown recognised that ultimately distribution was a real phenomenon (fight about real purchasing power of income shares) and the aspirations were pitched in real terms.

Thus Brown anticipated the Expectations-Augmented Phillips curve in the sense that he explicitly included inflationary expectations in his wage-price spiral framework even though the causality was strictly Keynesian (quantity disequilibrium to price change) rather than derived from the earlier work of Irving Fisher, which was picked up by the Monetarists.

Brown considered the economic cycle as being driven by fluctuations in effective demand (1955: 91) and, in an expansion, labour market disequilibrium (excess demand for labour) increases the bargaining power of unions and reduces unemployment.

When the expansion ceases there is a “sudden fall in the rate of wage increase” (1955: 91). During expansion and contraction, expectations of the movement in the cycle also drive the wage changes in both directions.

If Brown’s insights had have penetrated the Keynesian orthodoxy at the time, then much of the wind that blew Monetarism (via Milton Friedman) into our lives would have been attenuated.

However, the publication of Phillips paper in 1958 was more amenable to the hydraulic Keynesian orthodoxy and allowed, further on in the next decade, the Monetarist hijacking to occur.

It is clear that Brown’s understanding of the distributional impact on the inflationary process was lost on policy makers when responding to the OPEC oil price hikes.

They sought to stifle the accelerating inflation by suppressing spending via fiscal austerity (public spending cuts and/or tax increases) and tight monetary policy (increasing interest rates).

The resulting stagflation created a perception that the ‘Keynesian’ policies had failed and bestowed a sense of legitimacy on the free market approach, which had claimed that inflation was the result of lax government policy.

This view had been wholly discredited during the Great Depression by the work of John Maynard Keynes and others, but remained alive and well in the more conservative academic departments.

The result was that the long-standing dominance of ‘Keynesian’ policy was thus abandoned by a large number of economists in the 1970s.

It should also be noted that the American Keynesian economist Sidney Weintraub also developed a type of distributional struggle approach to inflation in his 1961 book, which exposited his ‘Keynesian theory of inflation’.

Paul Davidson (1994: 149) said that Weintraub considered inflation “is always the result of attempts to alter the existing distribution of monetay income among inhabitants” and thus “a symptom of a fight over the distribution of current income”.

But irrespective of whether one accords with a Monetarist-style version of the Phillips curve (where there might be a short-run but never a long-run trade-off between inflation and unemployment), a Marxist version based on distributional conflict, or even a modern Post Keynesian version of the Phillips curve as outlined in Palley (1996: 174), where there is a “long-run negatively slopped Phillips curve”, the framework still posits that unemployment buffer stocks are intrinsically related to the dynamics of inflation in one way or another.

Palley (1996: 180) claims that:

The critical insight was that unemployment can result from random shifts of demand between sectors, and that systematic aggregate nominal demand growth can be used to offset these employment effects: the benefit is reduced unemployment, the cost is higher inflation. To the extent that sectors with unemployment incorporate inflation expectations into their nominal wage settlements, this reduces the employment benefit of nominal demand growth. In the limit, if the coefficient of inflation expectations in these sectors is unity, then nominal demand growth cannot affect the unemployment rate.

So while Palley holds this out as a Post Keynesian inflation theory, it is, in fact, not (in the limit) different to the natural rate hypothesis model of Friedman and the Monetarists. The latter is a special case (coefficient of unity) of the former.

Palley also incorporated a “conflict approach to inflation” (p. 199) into his ‘demand-pull model’ and concluded that (p.199):

…The important policy inplications are that in a conflict environment, if target wages and mark-ups are exogenous, then policy makers may have no control over the rate of inflation using traditional monetary and fiscal policy measures. Such measures will impact on unemployment but yield no inflation benefit. This suggests that incomes policy, which is designed to reconcile the conflicting claims of workers and firms, is a superior policy.

If we accept this conception is representative of the received wisdom of the Post Keynesian approach to inflation then it is clear that MMT represents a diametric advance on it.

The current orthodoxy is driven by the dominance of the Monetarist natural rate rendition where full employment occurs at some unemployment rate where the inflation rate is stable (and price expectations are realised) and that there is very little the government can do via aggregate demand policy to influence that equilibrium.

There is some scope for demand-management policies in the short-run if the unemployment rate is above the natural rate (NAIRU) but that scope is finite and small.

Whatever theoretical construct is used to underpin the model the conclusion from each is simple: there is only one cyclically-invariant unemployment rate associated with stable price inflation.

The NAIRU concept has dominated macroeconomic policy making in most OECD countries since the late 1970s and the ‘fight-inflation-first’ strategies have exacted a harsh toll in the form of persistently high unemployment and broader labour underutilisation.

Under the sway of the NAIRU, policy makers around the world abandoned the pursuit of full employment as initially conceived.

This dominant theoretical model (the NAIRU) is still based on a ‘buffer stock of unemployed’ being the essential component for price stability.

Full employment is defined in terms of this buffer stock of unemployment rather than be related to the reality of there being enough jobs available to meet the desires of the available labour force.

MMT and buffer stocks

While the previous discussion has highlighted that the Monetarists, Post Keynesians and even Marxists have developed theories of inflation that relate unemployment to price level changes in some way, MMT economists have introduced a new idea – the use of employment buffer stocks.

MMT economists have introduced the idea that there are two types of buffer stocks that can both be manipulated by changes in government policy aimed at reducing aggregate demand pressures that fuel an inflationary spiral.

MMT juxtaposes:

The two broad buffer stocks we will compare and contrast are:

  • Unemployment buffer stocks: Under a NAIRU regime, inflation is controlled using tight monetary and fiscal policy, which leads to a buffer stock of unemployment. This is a very costly and unreliable target for policy makers to pursue as a means for inflation proofing.
  • Employment buffer stocks: The government exploits the fiscal power embodied in a fiat-currency issuing national government to introduce full employment based on an employment buffer stock approach. The Job Guarantee (JG) model is an example of an employment buffer stock policy approach.

The two approaches to inflation control both introduce so-called inflation anchors. In the NAIRU case, the anchor is unemployment, which serves to discipline the labour market and prevent inflation wage demands from being pursued.

Under a Job Guarantee, the inflation anchor is provided in the form of a fixed wage employment guarantee.

To realign nominal aggregate demand growth to be compatible with the available real income, and hence break out of the distributional conflict, the government has to reduce demand growth while trying to promote increased productivity and investment in productive capacity (that is, expanding the supply potential of the economy).

Expanding the supply potential of the economy is a medium- to long-term aim of the government and cannot be achieved in the immediate period.

That means that adjustments to aggregate demand growth are likely to be the focus of government policy when an inflationary spiral is threatening.

Policy thus has to find a way to induce some labour slack into the overheating economy so that incompatible distributional claims abate.

MMT argues that a superior use of the labour slack necessary to generate price stability is to implement an employment program for the otherwise unemployed as an activity floor in the real sector, which both anchors the general price level to the price of employed labour of this (currently unemployed) buffer and can produce useful output with positive supply side effects.

The two different buffer stock approaches also define particular approaches to fiscal policy conduct.

The NAIRU approach to price stabilisation sees the government spending on what we call a quantity rule. This means that the government bases its forward fiscal estimates on some quantity of dollars that it will spend at prevailing market prices to prosecute its socio-economic program.

Spending over-runs are usually met with cut-backs in an attempt to meet the fiscal estimates.

Conversely, the employment buffer stock approach represents a shift from spending on a quantity rule to spending on a price rule.

Accordingly, the government offers a fixed wage (that is, a price) to anyone willing and able to work, and thereby lets market forces determine the total quantity of government spending that would be required to satisfy the demand for public sector jobs under the Job Guarantee.

Spending on a price rule provides the government with a superior inflation control mechanism. When the private sector is inflating, a tightening of fiscal and/or monetary policy can shifts workers into a fixed-wage Job Guarantee sector to achieve inflation stability without causing costly unemployment.

While the unemployment buffer stock approach uses income loss as the threat to get workers to moderate their wage demands it is also a very costly approach and becomes more costly as time passes.

It is well documented that sustained unemployment imposes significant economic, personal and social costs that include:

  • loss of current national output and income;
  • social exclusion and the loss of freedom;
  • skill loss;
  • psychological harm;
  • ill health and reduced life expectancy;
  • loss of motivation;
  • the undermining of human relations and family life;
  • racial and gender inequality; and
  • loss of social values and responsibility.

These costs are very large and are irretrievable. In terms of the goals of macroeconomic policy they also present a major conflict. Mass unemployment involves perhaps millions of workers (depending on which nation were are referring to) not producing any output or national income. This violates any reasonable notion of macroeconomic efficiency.

Further, persistently high unemployment not only undermines the current welfare of those affected and slows down the growth rate in the economy below its potential but also reduces the medium- to longer-term capacity of the economy. The erosion of skills and lack of investment in new capacity means that future productivity growth is likely to be lower than if the economy was maintained at higher rates of activity.

The overwhelming quandary that the unemployment buffer stock approach to inflation control faces is whether the economy, once deflated by restrictive aggregate demand management, can be restarted without inflation.

If the underlying causes of the inflation are not addressed a demand expansion will merely reignite the tensions and a wage-price outbreak is likely. As a basis for policy the NAIRU approach is thus severely restrictive and provides no firm basis for full employment and price stability.

It success as an inflation anchor requires a chronic pool of high unemployment.

MMT shows that the Job Guarantee – which operates a buffer stock of jobs to absorb workers who are unable to find employment in the private sector – is a superior alternative to the unemployment buffer stock approach.

The capacity to run a Job Guarantee follows from the unique characteristics that the government has as the issuer of the currency under monopoly conditions. This is core MMT doctrine.

While MMT clearly owes a legacy to the past influences (Marx through Lerner and beyond) it has also uniquely brought together the characteristics of the currency with the theoretical challenge to maintain macroeconomic efficiency, which for all time has been described in terms of full employment and price stability.

The introduction of employment buffer stocks (the Job Guarantee), while influenced by the earlier work by Benjamin Graham and the agricultural price support schemes common in Australia in the 1970s, is a significant new innovation in macroeconomics because it challenges the entire notion of a Phillips curve (trade-off or otherwise).

For a progressive agenda, it shows how an understanding of how the currency is, in fact a public monopoly, allows us to understand that the monopolist in this context (currency-issuing government) can always set the price to address the major constraints on activist fiscal policy posed by the NAIRU-NRH school.

In this way, the introduction of employment buffer stocks has directly challenged the dominant orthodoxy by proposing a way to achieve full employment with price stability.

As Randy Wray noted in a 2011 Keynote Speech – MMT: A Doubly Retrospective Analysis – that the “buffer stock employment”:

… analogy to commodities price stabilization schemes added an important component that was missing from Minsky: use full employment to stabilize prices. With that we turned the Phillips Curve on its head: unemployment and inflation do not represent a trade-off, rather, full employment and price stability go hand in hand.

In this way, the body of theoretical work now known as MMT directly and intrinsically addresses the major macroeconomic debate about the trade-off between inflation and unemployment in a way that no other macroeconomic approach (mainstream or Post Keynesian) had before.

And the way MMT does that is intrinsic to its theoretical framework and logically consistent with it. It is crucial to understand that notions of price stability all have some buffer stock underpinning them.

The theoretical offering that MMT provides is that if we are concerned about efficiency and price stability then there is a superior buffer stock available to a public currency issuing monopoly.

That is, if we really understand the way the currency works and the way the labour market works then we can have both full employment and price stability by using an employment buffer stock rather than an unemployed buffer stock.

One might still understand the capacities of a currency-issuing government yet dislike the idea of an employment buffer stock being used.

By integrating the Job Guarantee into their macroeconomic framework, MMT economists can show that it is far better to conduct fiscal policy by spending on a price rule. That is, the government just has to fix the price and ‘buy’ whatever is available at that price to ensure price stability.

The price the government fixes is the price it offers labour to enter the employment buffer stock.

So in a fiat monetary system, price stability is maximised using employment buffers rather than unemployment buffers.

That insight is an essential part of the body of work that has become known as MMT and is an essential part of the understanding of how monetary systems operate and deliver macroeconomic outcomes.

There are those who might consider that the MMT proposal that national governments should first bolt down the nominal anchor via an employment buffer stock amounts to a disagreement with Post Keynesian policies of public infrastructure investment, which amount to ‘generalised expansion’.

Some might even think that the proposal to introduce an employment buffer stock amounts to a preference for ‘small government’ in the Hayekian tradition.

None of these views would be correct.

What we argue is that to turn the Phillips curve on its head – and thus thwart the use of unemployment to control inflation – you need a different nominal anchor. Generalised expansion does not provide that.

Once you have that anchor in place then your ideological preferences will determine what other public spending you might entertain within the capacity of the economy to embrace further nominal demand expansion.


The essential point is that independent of our preferences with respect to the size of government, the most effective anti-inflation strategy a currency-issuing government can implement is to maintain an effective and highly liquid employment buffer.

There is nothing in the extant New Keynesian or Post Keynesian literature that provides those insights. There is no discussion of employment buffer stocks.

It should be noted that the Job Guarantee is not just a public sector job creation scheme. If it was just that then we would have no claim to novelty.

The Job Guarantee in the body of work known as MMT provides a macroeconomic stability framework and avoids using unemployment as a means of achieving price stability.

While the mainstream theory of inflation and the extant Post Keynesian approach has been constructed within the Phillips curve framework, where the debate centres on the existence (and the nature) or otherwise of the trade-off between inflation and unemployment, MMT departs significantly from either approach.

By constructing the understanding of inflation within a buffer stock theory, the promotion of employment buffer stocks, allows MMT to reduce the Phillips curve to a single dot or point within the unemployment-inflation space.

Through the use of employment buffer stocks, a government can maintain what MMT calls ‘loose’ full employment with price stability.

In other words, the trade-off between unemployment and inflation disappears.

That insight is a clear advance on the previous ways of dealing with the relationship between unemployment and inflation in the literature – mainstream or Post Keynesian.


Aspromourgos, T. (2000) ‘Is an Employer-of-Last-Resort Policy Sustainable? A Review Article’, Review of Political Economy 12(2), 141-155.

Bernanke, B. (2004) ‘The Great Moderation’, Speech at the Meetings of the Eastern Economic Association, Washington, D.C., February 20, 2004.

Blanchard, O. (2008) ‘The State of Macro’, Annual Review of Economics, 1(1), 209-228.

Brown, A.J. (1955) The Great Inflation, 1939-51, Oxford, Oxford University Press.

Coddington, A. (1983) Keynesian Economics: The Search for First Principles, George Allen and Unwin, London.

Cornwall, J. (1989) ‘Inflation as a Cause of Economic Stagnation: A Dual Model’, in Kregel, J.A. (ed.) Inflation and Income Distribution in Capitalist Crisis, London, Palgrave, Macmillan, 99-122.

Davidson, P. (1994) Post Keynesian Macroeconomic Theory, Aldershot, Edward Elgar.

Devine, P. (1974) ‘Inflation and Marxist Theory’, Marxism Today, March, 70–92.

Fiebiger, B. (2012a) ‘Modern money and the real world of accounting of 1 -1 < 0: The U.S. Treasury does not spend as per a bank' in Working Paper No. 279, Modern Monetary Theory: A Debate, Political Economy Research Institute, University of Massachusetts, Amherst, MA.

Fiebiger, B. (2012b) ‘A rejoinder to ‘Modern money theory: a response to critics.’’ in Working Paper No. 279, Modern Monetary Theory: A Debate, Political Economy Research Institute, University of Massachusetts, Amherst, MA.

Graham, B. (1937) Storage and Stability, McGraw Hill, New York.

Kadmos, G., and P. O’Hara (2000) ‘The Taxes-Drive-Money and Employer of Last Resort Approach to Government Policy’, Journal of Economic and Social Policy, 5(1), 1-23.

King, J.E. (2001) ‘The Last Resort? Some Critical Reflections on ELR’, Journal of Economic and Social Policy 5(2), 72-76.

Krugman, P. (2009a) ‘On not listening’, New York Times, November 3, 2009 –

Krugman, P. (2009b) ‘How Did Economists Get It So Wrong?’, New York Times Magazine, September 2, 2009 –

Krugman, P. (2011) MMT, Again, New York Times, August 15, 2011,

Lavoie, M. (2011) ‘The monetary and fiscal nexus of neo-chartalism: A friendly critique’, Journal of Economic Issues, 47(1), 1–31.

Lavoie, M. (2014) Post-Keynesian Economics: New Foundations, Aldershot, Edward Elgar.

Lucas, R.E. Jnr (2003) ‘Macroeconomic Priorities’, American Economic Review, 93(1), March, 1-14.

Mehrling, P. (2000) ‘Modern Money: Fiat or Credit’, Journal of Post Keynesian Economics, 22(3), 397-406.

Mitchell, W.F. (1987) ‘The NAIRU, Structural Imbalance and the Macroequilibrium Unemployment Rate’, Australian Economic Papers, 26(48), 101-118.

Mitchell, W. F. (1996) ‘Inflation and Unemployment: A Demand Story’, presented to European Unemployment Conference, sponsored by the European Commission, at the European University Institute, Florence, November 21-22.

Mitchell, W.F. (1998a) ‘The Buffer Stock Employment Model and the Path to Full Employment’, Journal of Economic Issues, 32(2), June, 547-555.

Mitchell, W.F. (1998b) Essays on Inflation and Unemployment, PhD Thesis, University of Newcastle, NSW, Australia, February.

Mitchell, W.F. (2009) ‘On voluntary constraints that undermine public purpose’, Bill Mitchell – billy blog. December 25, 2009

Mitchell, W.F. and Wray, L.R. (2005) ‘In Defense of Employer of Last Resort: a response to Malcolm Sawyer’, Journal of Economic Issues, XXXIX(1), 235-244.

Mitchell, W.F. and Juniper, J. (2006) ‘Towards a Spatial Keynesian macroeconomics’, in Arestis, P. and Zezza, G. (eds.) The Keynesian Legacy in Macroeconomic Modelling, Macmillan, London.

Mitchell, W.F. and Muysken, J. (2008) Full employment abandoned: shifting sands and policy failures, Aldershot, Edward Elgar.

Mosler, W.B. (1997-98) ‘Full Employment and Price Stability’, Journal of Post Keynesian Economics, 20(2), Winter, 167-182.

Palley, T.I. (1996) Post Keynesian Economics, New York, Macmillan.

Palley, T.I. (2013) ‘Money, fiscal policy, and interest rates: A critique of Modern Monetary Theory’, mimeo, January.

Palley, T.I. (2014) ‘Modern money theory (MMT): the emperor still has no clothes’, mimeo, February.

Rowthorn, R. (1980) Capitalism, Conflict, and Inflation: Essays in Political Economy, London, Lawrence and Wishart.

Sawyer, M. (2003) ‘Employer of Last Resort: Could It Deliver Full Employment and Price Stability?’, Journal of Economic Issues, 37(4), December, 881-907.

Skidelsky, R. (2009) Keynes: The Return of the Master. London, Allen Lane.

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Wray, L.R. (1998) Understanding Modern Money, Vermont, Edward Elgar.

That is enough for today!

(c) Copyright 2016 William Mitchell. All Rights Reserved

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    19 Responses to Modern Monetary Theory – what is new about it? – Part 2 (long)

    1. Chrislongs says:

      Would the Job Guarantee offer equal pay to all?
      Sorry if I am opening a “can of worms” but I see this as essential to overcome current pay gap problems and offering some advantage in gaining acceptance.

    2. larry says:

      “The use of formality is only justified if it simplifies what cannot be easily said in words. Otherwise, it just perpetuates the idea that economics is just a cult of the cognoscenti who have learned a few elementary rules of pure mathematics.”

      This is so true. Let me give a simple algebraic example to illustrate Bill’s point. Take the formula, a+b = b+a. Noting that the order is important, try to put this formula into English. It can be done, but the result is less comprehensible than the formula.

    3. Bob says:

      “Would the Job Guarantee offer equal pay to all?”

      Of course!

    4. Jake says:

      Great blog.

      “Expanding the supply potential of the economy is a medium- to long-term aim of the government and cannot be achieved in the immediate period.”

      In the long,this will be important so the economy can absorb a labour surplus without inducing inflation.;what policies should gov pursue to lower risks of inflation and create “real” as opposed to “loose” full employment.

    5. Derek Henry says:

      Savings is such a small word but so important.

      Savings Is what allows the private sector to adjust to the increased demand. Sure the deficit might increase but that is a buffer stock in itself to help fight inflation.

    6. Jason H says:

      Chrislongs, yes it’s the same hourly wage for all. A permanent voluntary job for as many hours you want to work. Not sure why it needs to be asked. Why would there be differences in pay. It may rise above the private sector wage of that’s poverty wages but it will be a flat wage for everyone.

      Pavlina Tcherneva has a good video on it:

    7. Horatio Parker says:

      There appears to be a problem with this paragraph:

      “his view had been wholly discredited during the Great Depression by the work of John Maynard Keynes and others, but remained alive and well in the more conservative academic departments.”

      Great post, thanks.

    8. Mustsign topost says:

      Given that the neoliberal way is to merge and consolidate everything in private hands, the question is what and whose assets are the Jobbers going to work?

    9. Andy says:

      Maybe the elegance and simplicity of a full employment buffer stock is just too scary for our learned friends to contemplate given that it can be understood by anyone with a brain.

    10. Chrislongs says:

      Jason H,
      I asked the equal pay question as there are regional pay differences -in the UK a London allowance (extra pay) has existed for many years. I could envisage a

    11. Chrislongs says:

      Sorry last sentence should read
      I envisage a problem of forcing people out of high cost centres if a basic fixed wage introduced.

    12. Brendanm says:

      So the employed buffer stock is analogous to maintaining temperature control of a system by placing the system in thermal equilibrium with an “infinite” heat source at the desired temperature.

      The idealised unemployed buffer stock uses an “infinite” heat source at absolute zero and a “finite” heat source at higher than the desired temperature. The system maintains some temporary health by transferring heat from high to low, but eventually experiences entropic heat exhaustion and dies. The Phillips curve effect is essentially an artifact of the rate at which heat is transferred high to low.

      Not sure what the “heat” analogue is in economic terms though.

    13. Brendanm says:

      Bill: “The use of formality is only justified if it simplifies what cannot be easily said in words. Otherwise, it just perpetuates the idea that economics is just a cult of the cognoscenti who have learned a few elementary rules of pure mathematics.”

      Being a formal language nerd, I have to take issue with this claim. It is just too easy to talk high church rubbish (cf literary theory or dare I say economics) in natural languages. I would agree though with the implied criticism that differential equations are not a suitable tool for analysing a complex discrete system like the economy. Formal mathematics has many tools for handling this task though and using them would likely increase the completeness, consistency and comprehensibility of any model.

      Larry: “This is so true. Let me give a simple algebraic example to illustrate Bill’s point. Take the formula, a+b = b+a. Noting that the order is important, try to put this formula into English. It can be done, but the result is less comprehensible than the formula.”

      Looks like you are arguing the contrary, but the English version of this is “addition is commutative”. Slightly more characters, but fewer words.

    14. Jason H says:

      Chrislongs, as its locally administered I assume that could be worked out. Remember the idea is its temporary and the amount of private sector jobs should increase fairly quickly with all the extra so ending power and demand created.

    15. Some Guy says:

      Chrislongs:I envisage a problem of forcing people out of high cost centres if a basic fixed wage introduced.

      It is more a matter of ending the current reality: People worldwide are forced into high cost centers because there is work there. The high costs can reflect real costs – e.g. rent, land scarcity, high demand, low supply – so higher wages for high cost centers can go to landlords & raise costs more. That is what extra pay for London (or New York etc) would do. Building, renovating public housing – perhaps with some JG labor would be a much better way to improve conditions of poorer people native to high cost centres.

      The buffer stock concept works spatially – the JG would cause substantial but healthy, low-inflation growth in low cost &/or high unemployment areas. If people want to move (back) there – and they will, then why not? It would be a win-win-win for the individuals, the communities, and the nation. Everybody’s (idle) resources would be used more efficiently. In any case, the JG would naturally be smaller in high cost centers, because unemployment is lower there.

      The upshot is that spatial as well as temporal indexation is usually a bad, self-defeating idea. Better to solve cost problems more directly – after determining that that there is some real reason for wanting metropolises to be more congested.

    16. larry says:

      Brendanm, this also needs to be parsed into English, and it would amount to an English “translation” of the formula.

    17. larry says:

      Brendanm, if you wish to emphasize logic, then employing mathematics would not in logical terms increase the completeness of any theory more complex than arithmetic with addition (according to Goedel’s incompleteness proof), which is any substantive empirical theory. And, if the subject matter is discrete and you need to use the calculus, you can use the difference calculus and dispense with the differential calculus.

    18. larry says:

      Brendanm, you are right. My example is askew. I meant it to apply to sectoral balances discussions where Bill rightly uses algebraic formulas, as they show the relationships more clearly than English would do. My only excuse is that the Labour party and US political shenanigans are messing with my head.

      A better example for my purposes in the logical context you introduced would be this: There is no largest number, assuming for discussion that we are dealing with the set of integers. In the first-order predicate calculus, this would be rendered as -ExAy(x > y), x -= y, x, y are members of the set of integers. Rendered into English, as I am sure you know, this formula would “translate” as: There is no number x for any number y such that x is greater than y, given that x is unequal to y and they are both integers. Which just says that there is no largest (greatest) number. While the English is so much better, there are contexts in which the formula would be necessary, as I am sure you know. Just as when Bill discusses sectoral balances.

    19. Mike Ellwood says:

      I assume that implicit in the job guarantee scheme would be the possibility of high-quality training and education to achieve skills and qualifications useful in future in the job market as a whole (and sadly in the 21st century, this might have to include literacy education, especially for some former prisoners, as literacy among prisoners (at least in the UK) is statistically worse than among the population as a whole; numeracy may also be an issue).

      On the idea of jobs moving to the people, rather than the other way around: it should always be the aim that an unemployed person should be able to find a JG job within easy reach of their home. As well as convenience, it should reduce travel costs and carbon footprint, and could also help with community building.

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