May 31, 2019

The missing elephant of full employment policy

Comment on Bill Mitchell on ‘Talking of elephants ― plain old, garden variety fiscal policy’

Blog-Reference and Blog-Reference

With the actual economic situation of Japan in view, Bill Mitchell argues “If there were two lessons that can be taken from the GFC among others then we should know, once and for all, that, first, monetary policy (in all its glorious forms these days) is not a very effective tool for influencing the level of economic activity nor the price level, and, second, that fiscal policy is very effective in manipulating total spending and activity. Of course, those lessons provided the evidence that turned macroeconomics on its head because for several decades, as the Monetarist surge morphed into all manner of variants, tried to eulogise the primacy of monetary policy and rejected the use of fiscal policy.” and “Eventually, we will move beyond that but the pain of holding on to the myth is damaging for people, especially those who are without work, are underemployed or have been forced into early retirement by the poor economic performance in this austerity-biased era.”

The problem for Japan’s policymakers is currently this: “What happens if all the shots have been fired, but they’re not enough to keep the economy growing? The fact is that the low interest rates have not provided much support to growth anyway. … At that point, he [Gittins] says that ‘all that’s left’ is ‘increased government spending or tax cuts’.”

So, uneasily sitting on a mountain of government debt, Japan is ripe for another round of deficit-spending/money-creation. This seems to be a clear-cut MMT Moment. The problem is that the macroeconomics that underlies this conclusion is provably false.

Bill Mitchell argues within the familiar Keynesian macro framework. He has not realized that this paradigm is scientifically worthless.#1

The elementary version of the axiomatically correct Employment Law#2 is shown on Wikimedia.#3

From this equation follows:

(i) An increase in the expenditure ratio ρE leads to higher employment L (the Greek letter ρ stands for ratio). An expenditure ratio ρE greater than 1 indicates a budget deficit (= dissaving, credit expansion) of the household sector, a ratio ρE less than 1 indicates a budget surplus (= saving, credit contraction). ρE is supposed to be dependent on the interest rate Jc.

ρE is defined as C/Y, with C = consumption expenditures of the household sector. The ratio can easily be expanded to include deficit spending of the government sector, i.e. C'=C+G. This yields the total expenditure ratio ρE' with taxation T here set to zero.

(ii) Increasing investment expenditures I exert a positive influence on employment. I is supposed to be dependent on the interest rate Ji.

(iii) An increase in the factor cost ratio ρF≡W/PR leads to higher employment.

The complete Employment Law contains in addition profit distribution and foreign trade.

Item (i) and (ii) cover Keynes’ familiar arguments about aggregate demand. The Employment Law shows how monetary policy via the interest rates Jc and Ji and fiscal policy via the total expenditure ratio ρE' moves the economy towards full employment. This is the plain garden variety of employment policy. It crucially depends on an interest elasticity greater than zero.

However, the right side of the Employment Law shows that there are additional policy parameters.

The factor cost ratio ρF as defined in (iii) embodies the macroeconomic price mechanism. The fact of the matter is that overall employment INCREASES if the AVERAGE wage rate W INCREASES relative to average price P and productivity R. This is the OPPOSITE of what microfounded economics teaches.

It follows that employment policy does not work if ρF is not properly controlled. Economic policy has to make sure at least that the average wage rate W rises in lockstep with productivity R and price P, i.e. W/PR = const., in order to keep employment at the level as determined by aggregate demand.

So, the set screws for controlling employment are the interest rates Jc and Ji, government (deficit) spending G, and ρF. Bill Mitchell completely ignores the macroeconomic price mechanism that is formally embodied in ρF. It is not sufficient to fix the minimum wage, the average wage rate W and the average price P, too, have to be controlled.

False theory leads to false policy guidance. With their defective employment theories, economists bear the intellectual responsibility for the social devastation of mass unemployment. Neither the garden variety of employment policy nor MMT deficit-spending/money-creation alone are suitable to establish full-employment.#4

Both traditional Employment Theory and MMT are axiomatically false and because of this, economic policy guidance has never been more than clueless blather.

Egmont Kakarot-Handtke

#1 The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment
#2 The macrofoundations approach starts with three systemic axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X. For a start it holds X=O.
#3 Wikimedia AXEC62 Employment Law
#4 For details of the big picture see cross-references Employment.

Related 'Full employment through the price mechanism' and 'Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster' and 'Wage rate and employment: the basics' and 'NAIRU, wage-led growth, and Samuelson's Dyscalculia' and 'Go! ― test the Profit and Employment Law'.