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It is Wednesday and despite being on the other side of the Planet than usual (in Helsinki at present) I am still not intending to write a detailed blog post today. I am quite busy here – teaching MMT to graduate students and other things. But I wanted to follow up on a few details I didn’t have time to write about yesterday concerning the role that NAIRU estimates play in maintaining the ideological dominance of neoliberalism. And some more details about the Textbook launch in London on Friday, and then some beautiful music, as is my practice (these days) on Wednesdays. As you will see, my ‘short’ blog post didn’t quite turn out that way. Such is the tendency of an inveterate writer.

Macroeconomics Textbook Launch – London, Friday, March 1, 2019

There are a few places left and the list closes 17:00 (Wednesday).

If you want to come, please E-mail me and I will get your name put on the door.

The program for the Book Launch in London of Friday is more or less decided:

  • 17:00 Doors open (light refreshments will be served)Doors open (light refreshments will be served)
  • 17:20 A welcome from Macmillan International Higher Education & introduction to the launch of Mitchell, Wray & Watts: Macroeconomics 1e – (Philip Rees/Jon Peacock/Jon Finch)
  • 17:30 An introduction to the book! – Dr Sandy Hager (City University)
  • 17:45 Integrating the MMT approach into the delivery of Macroeconomics HE courses – Professor Heikki Patomaki (Helsinki University)
  • 18:00 A word from our author! – Professor Bill Mitchell (University of Newcastle, Australia & Director of CofFEE – (Centre of Full Employment & Equity, University of Newcastle))
  • 18:15-18:30 Q&As (compered by Philip Rees, Macmillan)
  • 18:45 Finish

Location: The event will be held at the Macmillan publishers complex at the Springer Nature – Stables Building, Trematon Walk, Kings Cross, London from 17:00 to 19:00.

Here is a short video introducing the features of the new textbook

Introduction MMT Macroeconomics Textbook 2019 - YouTube

Helsinki Lecture Series

My lecture series at the University of Helsinki in my role as Docent Professor of Global Political Economy, at that university, is underway.

Lecture 1 (Tuesday) attracted a good number including many non-enrolled people from the general public.

The lectures are part of a formal program but the public is welcome to attend subject to lecture hall space being available.

The remaining lecture schedule is:

  • Wednesday, February 27 – 12.15–13.45
  • Thursday, February 28 – 12.15–13.45
  • Tuesday, March 5 – 10.15–11.45
  • Wednesday, March 6 – 12.15–13.45
  • Thursday March 7 – 12.15–13.45

They will be held in Lecture hall XV (fourth floor) at the University of Helsinki main building, entrance from Unioninkatu.

I have arranged for them to be filmed and when I get access to the footage I will make them available to those who cannot attend.

Output gaps and unemployment gaps – short reprise

In yesterday’s blog post – The NAIRU/Output gap scam (February 25, 2019) – we considered in some detail the way in which economists seek to ‘measure’ when an economy is operating at full capacity or full employment. We learned that the measurement process is fraught but not unmanageable. But the real problem is that the process can be hijacked using loaded concepts (such as the NAIRU), which deliberately bias the results of the empirical work towards concluding that fiscal deficits are too expansionary when, in fact, they are too contractionary and vice versa.

At the extreme, we get ridiculous claims from technocratic economists in places such as the European Commission that a nation’s full employment unemployment rate rises from below 10 per cent to 23 per cent in a matter of two or so years due to structural forces that are immutable to government fiscal policy action (such as spending more cash to stimulate sales and create more work).

But even within the limits of the ridiculousness, the bias is profound and nations are forced into imposing fiscal settings that are totally inappropriate for their economies, given the state of non-government spending at the time.

So we see fiscal austerity being imposed when private sales are lagging and unemployment is rising.

And harsh microeconomic policy changes invoked – privatisation, deregulation, wage and income support cuts, etc – which are justified by the claim that the prevailing mass unemployment is purely structural in nature and cannot be dealt with through increasing total spending in the economy.

There was one other graph I constructed to highlight the problems of measurement in this realm of applied economics.

The output gap is conceptually the real output shortfall in an economy relative to its potential (or full capacity) limit.

So in Modern Monetary Theory (MMT) parlance it measures the real resource space available in the economy.

It is a conceptual quantity – that is, you cannot observe it.

We observe manifestations of it – mass unemployment, unsold inventories, idle capital etc – which then can help us create proxies in order to measure the unobserved gap.

It is typically derived (estimated) by mainstream economists using another unobserved concept – the NAIRU, which is the unemployment rate where inflation is stable.

The NAIRU was the mainstream replacement for the older notion of full employment.

It was always recognised that some unemployment would always be evident (people moving beteween jobs, for example).

So full employment was logically conceived as there being enough jobs to meet the desires for work from the labour supply.

We can refine that concept to include desired hours of work (to eliminate underemployment).

But the NAIRU recast that conceptualisation and instead redefined full employment to be the unemployment rate where inflation is stable.

Thus, conceptually, the gap between the actual unemployment rate and the estimated (unobserved) NAIRU should measure the non-inflationary space available to reduce actual unemployment.

If that gap – NAIRU minus unemployment rate – is positive then we would expect (according to the theory) inflation to be accelerating.

Conversely, if the gap is negative, then we should expect the opposite.

Various bodies (such as the European Commission, IMF, etc) provide estimates of the NAIRU through a variety of econometric/statistical gymnastics.

The problem is that the estimated gaps between the NAIRU and actual unemployment do not correspond with movements in inflation.

This became very evident early on in the 1990s.

For example, the NAIRU estimates (after the 1991 recession) rose significantly.

Then as the economies around the world recovered and the actual unemployment rates fell, we observed inflation also falling even though the gaps (NAIRU minus actual) were becoming strongly positive.

How could that be?

More gymnastics – bring in the so-called time-varying NAIRU – that is allow it to shift downwards and upwards.

Cutting through all the technical stuff at the time, it was obvious that the estimated NAIRUs were just filtered versions of the actual, which moved in concert with the spending cycle.

In other words, the ‘structural’ benchmark (the NAIRU) was just another representation of the cyclical shifts in employment and unemployment and there was very little if anything structural about it.

I wrote about that in one of my early academic publications where I was the first person to really provide an applied framework for estimating the dependency between the two (hysteresis) – see The NAIRU, Structural Imbalance and the Macroeconomic Equilibrium Unemployment Rate (June 1987).

The point is that the two measures of free capacity – the output gap and the unemployment gap – should be closely related if they are to be of any policy use.

If they deviate significantly in estimating how much free resource capacity there is then there is a problem of measurement.

This graph demonstrates that problem.

It is constructed using AMECO data (mentioned in yesterday’s blog post) and shows the correlations for the nation’s concerned of their NAIRU and output gap time series going back to 1985.

The correlations are not particularly strong across the board.

In Italy’s case, the output gap and the NAIRU measures are very divergent, which tells us that one or both are not fit for their stated purpose.

Relatedly, a central bank friend reminded me today of some of the detail surrounding the European Commission’s NAIRU antics in 2013 concerning Spain.

I discussed that in yesterday’s blog post.

In this Working Paper from the German-based Macroeconomic Policy Institute from January 2015 – The European Commission’s New NAIRU: Does it Deliver? – we read that:

1. “The NAIRU is a key component of potential output and as such critically affects output gap estimates” – which is the point I made yesterday. If the NAIRU estimates are cooked, so will the potential output measures be cooked.

2. “Potential output, in turn, is of great relevance for economic policy makers because it represents a barrier to inflation- stable growth and determines the extent to which a given fiscal deficit is interpreted as cyclical or structural” – again what this seemingly technical debate is all about.

Cooked NAIRU -> cooked Potential Output -> cooked Output Gap.

And if the cooked NAIRU is biased to find that the economy is closer to full employment than it actually is, then the cooked output gap measures will suggest the economy is closer to full capacity, which will then mean the current fiscal position will be interpreted as being ‘mostly’ structural.

3. “The autumn 2013 forecast of the Spanish NAIRU for 2014 (25 %) almost equaled the unemployment rate in November 2014 (25.8 %). As Spanish unemployment was declining at the time, the unemployment rate was poised to undershoot the NAIRU in 2015 … An unemployment rate of over 20% entailing youth unemployment of more than 50% was thus interpreted labor market tightness.”

And anyone with half a brain immediately concluded as the MPI concluded that this was an “implausible outcome”.

The European Commission came under sustained attack for this ridiculous result and by the European Spring of 2014 they announced they were changing the model specification of NAIRU.

Okay, and then what?

We read that:

Rather than climbing to 26.6% in 2015, the new NAIRU estimate for 2015 was 20.7%.

Remember, that just two years before the NAIRU was estimated to be around 8 per cent.

In the intervening few years, it was implausible to believe that sudden ‘structural’ forces had changed the full employmnet unemployment rate so markedly, especially as Spain was in the midst of a major cyclical downturn.

The European Commission was trying to tell people that there were no cyclical factors at work determining the Spanish unemployment rate.

Absurd.

It is not my intention to review the technical detail in the MPI paper notwithstanding how interesting it is.

Suffice to say, their Figure 1 shows how dodgy this whole exercise is. The different NAIRU estimates keep failing (when considered against the trajectory of the actual unemployment rate) and what the gap between the two would signify for the state of the economy.

So the next time the Commission technocrats crank out the estimates – we see different profiles.

And as the actually unemployment rate rises (around 2007) the NAIRU estimates are also revised upwards, following the actual rate up.

The point the MPI paper makes, which is the point I made in the 1987 paper I cited above is that the unemployment rate trajectory is dominated by cyclical shifts in spending, sales, output and employment.

If the NAIRU basically tracks the actual rate then what independent ‘structural’ information is it providing.

The answer is none, in all probability.

The MPI paper thus tests:

… the dependence of the NAIRU on unemployment versus structural factors …

Leaving aside the technical details of how they did that – essentially they ran regressions of the NAIRU estimates on structural and cyclical variables, to differentiate the two influences – their conclusion is categorical

1. “the NAIRU does not seem to be very responsive to changes” to the structural proxies “as compared to changes in the unemployment rate”.

2. “In general … [the structural shocks] … are largely irrelevant”.

3. “Although interpreted as structural unemployment unaffected by aggregate demand, the EC’s NAIRU turns out to be quite resilient to structural reforms. The estimate is largely driven by actual unemployment.”

Which means that such measures are misleading when applied to policy, and, given the way the bias plays out in the measures – the application is likely to be highly damaging – as we have seen in many countries.

The MPI paper concludes that “output gaps be given less weight in fiscal policy decisions”.

I would conclude that there are much better ways of estimating these things if one abandons the neoliberal mindset that shapes the statistical representations to deliver results that reinforce the dominant ideology.

As the MPI paper notes “the EC does not model the NAIRU to include hysteresis effects”, for a start!

Music for a busy Wednesday

Jet lag means one wakes up in the middle of the night ready for work – notwithstanding the accompanying headaches from lack of sleep. We all know the drill.

So in the quiet, dark hours one seeks comfort from some music to provide the metre for the typing.

This morning, I have been listening to a Dutch pianist, Annelie de Vries, who recently released her debut Post Minimalist CD – After Midnight.

It is a very soothing set of piano pieces, recorded on a very creaky upright piano that she apparently loves to play.

Here is one of the tracks – At Night – it is very lyrical. I think I will work it out and play it myself when I get home to my piano.

At Night - YouTube

That is enough for today!

(c) Copyright 2019 William Mitchell. All Rights Reserved.

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Remember back in early 2009, when the then head of the European Central Bank Jean-Claude Trichet (boasted that the “euro … is a success … it helps to secure prosperity in participating states”. He was still making these claims in October 2018. At an event in honour of he and former German finance minister Theodor Waigel, organised by the Banque de France, Trichet said that “the euro is a historic success … in terms of credibility, resilience, adaptability, popular support and real growth during its first 20 years is impressive”. He particularly singled out the “delivery of price stability”. Well the latest data confirms beyond doubt that the ECB has failed to deliver on its price stability charter. Further, the descent back into recession in Italy and probably Germany in the December-quarter 2018 tells us that this reliance on monetary policy to stimulate growth while maintaining ridiculous levels of fiscal rectitude has undermined growth and unnecessarily condemned millions to unemployment and rising poverty.

The ECB describe that the objective of its monetary policy is “to maintain price stability”.

They define “price stability” as:

… a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2% … the ECB aims at maintaining inflation rates below, but close to, 2% over the medium term.

That would appear to be clear enough and one would certainly allow some latitude around the 2 per cent target in the short run. But that would exclude systematic departures from the target over an extended period.

I will come back to the claim about success in fostering real growth later.

But consider the following graph, which shows the annual inflation rate (Harmonised Index of Consumer Prices – HICP) from January 2001 to December 2018 – the span of the euro to date.

The data shows that the inflation rate has been anything but stable under the watch of the ECB.

And, the latest advice from Eurostat is that the annualised inflation rate is likely to drop to 1.4 per cent in January 2019, down from 1.6 per cent in December 2018 (Source):

How does one reasonably interpret this apparent failure?

Given the lack of concerning commentary from the ECB and the sort of boast epitomised by Jean-Claude Trichet’s ‘success’ claims, one interpretation is that the ECB is content with maintaining a deflationary bias in contradistinction to its stated monetary policy objective.

Its behaviour as part of the Troika would support that interpretation.

The other conclusion that could be drawn is that the ECB has just plain failed to fulfill its stated policy mandate.

In other words, the claims that the euro has been a success in terms of maintaining price stability are just nonsensical.

The behaviour of the data is not surprising to an analyst cognisant with Modern Monetary Theory (MMT).

In the absence of an institutional bias towards inflation (indexation schemes, etc) or a imported raw material (for example, energy) shock, inflation will be low if not negative if aggregate spending growth in the relevant ‘economy’ is weak (in relation to what is required to maintain high pressure and low unemployment).

So the specific lack of correspondence between the actual Euro area inflation rate and the ECB’s price stability target provide us with evidence that the Euro area has been wallowing in a low growth environment, contrary to Jean-Claude Trichet’s other claim in 2018 that the euro has been a “historic success” in terms of promoting strong real growth.

The other interesting conclusion that we can draw in terms of matching the data with the more recent statements from the ECBs President and members of the ECB Board is that monetary policy is largely incapable of generating accelerating inflation.

For example, on July 3, 2014, ECB President Mario Draghi’s – Introductory statement to the press conference (with Q&A) – announcing the “outcome of today’s meeting of the Governing Council” noted that:

As our measures work their way through to the economy, they will contribute to a return of inflation rates to levels closer to 2% … the key ECB interest rates will remain at present levels for an extended period of time in view of the current outlook for inflation …

… the Governing Council is unanimous in its commitment to also using unconventional instruments within its mandate, should it become necessary to further address risks of too prolonged a period of low inflation.

So it was clear then that the ECB was pursuing monetary policy – both interest rate setting and the other ‘non-standard’ interventions – with the intent of pushing the inflation rate back to 2 per cent on a stable basis.

It is pretty clear they have not been able to have much influence on the evolution of the Euro area price level.

They certainly haven’t been able to achieve an acceleration in the inflation rate.

This has massive implications for how one assesses the validity of Modern Monetary Theory (MMT) viz the dominant mainstream New Keynesian macroeconomics.

The latter has a preference for what they term monetary policy assignment over fiscal policy because they claim that monetary policy is an effective instrument for maintaining full employment and price stability.

The evidence certainly does not support that preference.

It is easy to dismiss this as an issue confined to the Eurozone, given how dysfunctional the architecture of the that monetary system has proven to be.

But the evidence of monetary policy ineffectiveness is also present in Australia (as an example).

Last Wednesday (January , 2019), the Australian Bureau of Statistics (ABS) press release – CPI rose 0.5 per cent in the December quarter 2018 – accompanied the latest inflation data for Australia, which showed that the:

CPI rose 1.8 per cent through the year to the December quarter 2018, after increasing 1.9 per cent through the year to the September quarter.

The ABS spokesperson said that:

Over the past four years, annual growth in the CPI has only risen above 2 per cent in two of the past 16 quarters.

The 2 per cent threshold is the lower limit of the Reserve Bank of Australia’s inflation targeting range of 2 to 3 per cent.

The following graph shows the annual headline inflation rate since the first-quarter 2002. The black line is a simple regression trend line depicting the general tendency. The shaded area is the RBA’s so-called targeting range (but read below for an interpretation).

The trend inflation rate is quite steeply downwards.

The RBA’s formal inflation targeting rule aims to keep annual inflation rate (measured by the consumer price index) between 2 and 3 per cent over the medium term. Their so-called ‘forward-looking’ agenda is not clear – what time period etc – so it is difficult to be precise in relating the ABS data to the RBA thinking.

What we do know is that they do not rely on the ‘headline’ inflation rate. Instead, they use two measures of underlying inflation which attempt to net out the most volatile price movements.

For a detailed discussion of these different inflation measures see this blog post – Australian inflation data defies mainstream macro predictions – again (November 1, 2018).

The following graph shows the three main inflation series published by the ABS since the March-quarter 2009 – the annual percentage change in the All items CPI (blue line); the annual changes in the weighted median (green line) and the trimmed mean (red line).

The RBAs inflation targeting band is 2 to 3 per cent (shaded area). The data is seasonally-adjusted.

The three measures are all currently well below the RBA’s targeting range:

1. CPI measure of inflation – 1.8 per cent.

2. The RBAs preferred measures – the Trimmed Mean (1.8 per cent and stable) and the Weighted Median (1.7 per cent and stable).

The evidence is that the RBA has not been very successful at stabilising the inflation rate (any measure) within its target range.

The current divergence away from the lower inflation targeting bound, coupled with a poor national accounts result for the September-quarter 2018 (see blog post – Australian national accounts – economy is slowing and looking shaky (December 5, 2018)), would suggest that the RBA should be cutting rates back down to record low levels.

The commentators are mostly programmed by the New Keynesian macroeconomic bias to call for interest rate cuts when inflation is decelerating.

They have become so dependent on seeing counter-stabilisation (influencing aggregate spending and eocnomic activity) as a responsibility of central banks that they always seek answers in manipulating monetary policy settings.

The problem is that central bank interventions are not very effective nor predictable in terms of counter-stabilisation, as the last decade has certainly taught us.

One commentator who understands this point is Australian Michael Pascoe, who in his recent article (January 31, 2019) – The ‘cut interest rates’ chorus is out of tune with reality.

He wrote that:

The “Reserve Bank must cut interest rates” chorus is growing louder. Too bad it’s barking up the wrong policy tree. Or maybe that should be, singing the wrong tune …

I haven’t met or heard of a single business person in the last couple of years who has said: “You know, I’d like to hire another employee or perhaps invest in a new piece of equipment, but I’m just waiting for the RBA to trim the cash rate another 25 points.”

It is obvious that at present we have:

1. Flat to falling real wages.

2. Sharp declines in housing prices creating a “negative wealth effect” on household consumption.

3. Dramatic slowdown in real GDP growth in the September-quarter 2018.

4. Other indicators such as the “business conditions survey” showing a “sharp downturn”.

5. Weak demand for credit at a time when household debt is at record levels. This is an important part of the story. Mainstream macro holds out that monetary policy can stabilise credit growth. The reality is that credit growth is much more dependent on economic activity and will be weak (strong) no matter what the interest rate is if aggregate spending is weak (strong).

In those circumstances, the RBA can cut interest rates to their heart’s content and there will no stimulatory effect.

Private borrowing will be unresponsive in these conditions.

Michael Pascoe draws the obvious conclusion, which is fully consistent with the basic insights that MMT provides:

Targeted fiscal stimulus could be more effective than rate cuts …

He uses the example of housing policy:

With housing construction slowing, there is an excellent opportunity for governments of all levels to face up to their failure to address social and affordable housing.

A new Productivity Commission report has shown our investment in social and affordable housing has not kept pace with our population.

State governments increasingly outsource government housing to community housing bodies that can’t keep up. Our reliance on individuals to provide rental accommodation also is a factor in our very high household debt levels …

… multiple benefits would flow from governments seriously increasing spending to build more affordable and social housing.

On August 20, 2014, the RBA’s Annual Report for 2013 was considered by the House of Representatives’ Standing Committee on Economics.

The – Hansard – records that the then Governor (Mr Stevens) told the Committee that:

Let me not give gratuitous advice on fiscal policy — and monetary policy is not the answer really for some of the most fundamental things …

He then invited his Deputy (Philip Lowe, now the Governor) to elaborate.

Philip Lowe told the Committee that:

At the end of the day, monetary policy cannot be the engine of growth in the economy. We can help smooth out the fluctuations, but we cannot in the end drive the overall growth in the economy …

I think if we need to invest more and more effectively in education, in human capital accumulation and in infrastructure. Risk taking, education and infrastructure are the things that are going to help us be a high-wage, high-productivity, high value-added economy. The details here are not things that the central bank is expert in, but it seems to me that they are the ingredients to be a successful economy in the next 20 years.

So fiscal policy must be prioritised as MMT economists promote.

The bias towards monetary policy that comes from the dominance of New Keynesian macroeconomics has starved nations of essential spending to maintain high levels of employment and low levels of labour wastage; has led to degraded public infrastructure and education systems; and left a generation of young people with poor prospects (often unemployed for all their youth).

The bias towards fiscal austerity that has accompanied this bias towards monetary policy is undermining the prosperity of the next generations.

And now we go to Italy …

And we don’t have to look very hard to see how that austerity bias is playing out in the Eurozone.

Eurostat latest national accounts data released last week (January 31, 2019) – GDP up by 0.2% in the euro area and by 0.3% the EU28 – shows the Euro area growth rate was 0.2 per cent in the December-quarter 2018.

It was 0.2 per cent in the third-quarter and half the growth rate in the first two quarters of 2018.

The annual growth rate has fallen from 2.4 per cent (March-quarter 2018) to 1.2 per cent (December-quarter) and will fall further in the March-quarter 2019, when the data is available.

Close to stagnation.

The data for the individual Member States shows that:

1. Italy contracted by 0.3 per cent in the December-quarter and is now back in official (technical) recession. The third recession in a decade – a disastrous outcome and unambiguous testament of the way the common currency has failed that nation.

2. It is likely that Germany will also record a second consecutive quarter of negative growth

The German statistical agency – Destatis – informs us that (Source):

General government achieved a record surplus of 59.2 billion euros in 2018 (2017: 34.0 billion euros). At the end of the year, central, state and local government and social security funds recorded a surplus for the fifth time in a row, according to provisional calculations. Measured as a percentage of the gross domestic product at current prices, this was a 1.7% surplus ratio of general government for 2018.

This is a huge drag on the economy and it is no wonder it is heading back into recession.

The following graph shows the quarterly real GDP growth in the three large Eurozone economies over the last three years. It has been all downhill for the last two years.

When the new Italian government outlined plans to expand the fiscal deficit (for one year only, ffs) the technocrats in Brussels moved in quickly to choke any hope of expansion off.

The ECB allowed that bullying to be realised by letting the spreads on Italian government bonds against the bund to rise quickly, creating a sense of impending financial crisis.

On January 14, 2019, the Banca d’Italia released its latest results for its – Survey on Inflation and Growth Expectations – 2018 Q4.

This is a survey of “industrial and service firms” which examines “the firms’ expectations for consumer price inflation, developments in their own selling prices, and their views on the macroeconomic outlook.”

The following graph shows the proportion of worse responses to the question “Assessment of the general state of the economy with respect to previous quarter”.

That pessimism then drives business firms in Italy to reduce their planned investment as the following graph shows.

So the proportion of business firms in Italy that expect to decrease investment has risen sharply in the last 6 months.

This will not only affect economic growth over the next few quarters (via the direct expenditure effect) but also reduce potential growth (via the supply-side effect).

Three recessions in a decade is a sign of major policy failure.

It is hard to see it in any other terms given that appropriate use of fiscal policy can always prevent a recession from occurring.

Conclusion

So two things arise.

First, central banks around the world have been using ‘loose’ monetary policy as a tool for accelerating inflation and have failed.

They believed in the New Keynesian (mainstream macro) model and it has shown itself to be a failure.

Second, this bias towards monetary policy overlaid with the rampant neoliberalism of the European Union’s pet baby, the common currency, has derailed reasonable fiscal policy interventions and its largest economies are heading ‘south’ again.

And then they wonder why people want to leave the EU, or march in the streets in yellow vests, or elect far right politicians who give voice in the absence of any effective Left engagement to the peoples’ angst.

Call for financial assistance to make the MMT University project a reality

I am in the process of setting up a 501(c)(3) organisation under US law, which will serve as a funding vehicle for the MMT Education project – MMT University – that I hope to launch early-to-mid 2019.

For equity reasons, I plan to offer all the tuition and material (bar the texts) for free to ensure everyone can participate irrespective of personal financial circumstance.

Even if I was to charge some fees the project would need additional financial support to ensure it will be sustainable.

So to make it work I am currently seeking sponsors for this venture.

The 501(c)(3) funding structure means you can contribute to the not-for-profit organisation (which will be at arm’s length to the not-for-profit educational venture) in the knowledge that your support will not be publicly known.

Alternatively, if you wish to have your support for the venture publicly acknowledged there will..

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Things seem to come in cycles. We have been at this for some years now – trying to articulate the principles of Modern Monetary Theory (MMT) in various ways in various fora. There is now a solid academic literature – peer-reviewed journal articles, book chapters in collections, and monographs (books) published by the core MMT group and, more recently, by the next generation MMT academics. That literature spans around 25 years. For the last 15 odd years (give or take) there has been a growing on-line presence in the form of blog posts, Op Ed articles etc. More than enough, perhaps too much for people to wade through. Each period seems to raise the same questions as newcomers stumble on our work – usually via social media. The questions come in cycles but there is never anything raised in each cycle that we have neglected to consider earlier – usually much earlier. When we set out on this project we tried to be our own critics because our work (in this area) was largely ignored. So we had to contest each of the ideas – play devil’s advocate – to stress test the framework we were developing (putting together pieces of knowledge from past theorists, adding new bits or new ways of thinking about them and binding it all together with interesting and novel connections and implications). So it is continually testing one’s patience to read the same criticism over and over again. Please do not get me wrong. When these queries are part of the learning process from a reader who is genuinely trying to work out what it is all about there is no issue. Our role as teachers is to see each generation safely through their educative phase in as interesting a manner as we can. But when characters get on the Internet, some with just a year, say of postgraduate mainstream study and start making claims about what we have ignored or left out or got wrong then it can be trying. Ignoring them is the best strategy. But then the genuine learners get confused. So this blog post is Part 1 of a two-part series seeking to help answer two major issues that we keep being asked about – (a) Does MMT only advocate tax increases to fight inflation?; and (b) How can any meaningful jobs be offered in a Job Guarantee if the workforce is ephemeral by construction? Part 2 will come tomorrow.

This is the sort of rubbish that is on the Internet about MMT, more or less, every day at present.

The first character is an economics PhD student at a low-tier US university. He has a long way to go. The second is not an economist but thinks he knows all about it.

Apparently, MMT academics have no formal training in economics and I am a crank, etc.

This is what goes for informed discussion these days. Pity the world.

Some background reading

By way of background and more detailed reading of the topics for this series:

1. An MMT response to Jared Bernstein – Part 1 (January 8, 2018).

2. An MMT response to Jared Bernstein – Part 2 (January 9, 2018).

3. An MMT response to Jared Bernstein – Part 3 (Jamuary 10, 2018).

4. Planning public works – history has a lot to say if we listen properly (January 30, 2018).

5. Functional finance and modern monetary theory (November 1, 2009).

The implementation of the Job Guarantee

The first question that is continually being recycled is this:

If the Job Guarantee is meant to be a flexible buffer stock and workers can be bid out of it on any day by non-government employers, surely the sort of work that is possible under those circumstances must be fairly unimportant and dispensable.

The impolite version of the question is that the jobs must just be an unproductive waste of time.

It is a good question.

I considered many aspects of this question in this blog post – Boondoggling and leaf-raking … (April 22, 2009).

In 2008, my research centre (the Centre of Full Employment and Equity – CofFEE) published a major report – Creating effective local labour markets: a new framework for regional employment policy – that followed three to four years of research.

Chapter 13 considered the Job Guarantee as an integral part of the proposed framework and provided a very detailed model of how such a policy intervention could be effectively implemented.

We considered the possible ephemeral nature of Job Guarantee workers in detail.

I have also written several academic papers about this issue (in part).

To really get a feel for the issue we have to take a step back. This will also help us understand the wrongful, but often repeated, assertion that inflation control in Modern Monetary Theory (MMT) relies exclusively on tax increases. That will be the topic of Part 2.

The orthodox approach to inflation control using buffer stocks of unemployment is costly and unacceptable.

The neoliberal solution to the resulting unemployment is to pursue supply-side policies (labour market deregulation, welfare state retrenchment, privatisation, and public-private partnerships) to give the economy room to expand without cost pressures emerging.

Progressive economists, in general, reject this strategy because the sacrifice ratios are high and the distributional implications (creation of an under-class and working poor and loss of essential services) are unsavoury.

Many economists working in the heterodox tradition advocate ‘Keynesian’ remedies as an alternative.

Specifically, they advocate ‘generalised’ fiscal and monetary expansion mediated by incomes policy and controlled investment as a solution to unemployment.

A simple construction of this view is that government fiscal policy injects new net spending into the economy whenever non-government spending falls below the level necessary to maintain full employment.

Conversely, when total spending is above the level necessary to maintain full employment the government cuts its net spending contribution.

Please read my blog post – The full employment fiscal deficit condition (April 13, 2011) – for more discussion on this point.

Under the generalised expansion approach the government ensures spending is sufficient to purchase all available output by the government itself purchasing goods and services at market prices or by the government providing incentives to profit-seekers to expand activity through tax cuts, subsidies etc.

Both policy measures will be conducive to employment expansion in the non-government sector. Typically, public and private capital formation is targeted.

Of course, the opposite dynamics can also eventuate – spending cuts and/or tax increases – if there is an inflationary boom threatening.

There are four major MMT-based criticisms of the generalised expansionary approach.

First, indiscriminate demand expansion in isolation is unlikely to lead to employment opportunities for the most disadvantaged members of society.

Second, generalised expansion fails to address spatial (regional) labour market disparities which are now common within most nations.

Third, generalised expansion does not incorporate an explicit counter-inflation mechanism.

Fourth, how does generalised expansion address environmental concerns given that market allocations are the basis for the employment expansion?

I addressed the regional disparity issue in many academic papers by developing a spatially targeted employment policy, which I referred to as Spatial Keynesianism, in contrast to the bluntness of orthodox Keynesian tools which fail to account for the spatial distribution of social disadvantage.

Spatial Keynesianism builds on the understanding that a generalised expansion will not have the capacity as a stand-alone policy to target regions in need of employment creation which may be reliant on a declining industry.

Further, aggregate policy is not able to account for feedback or spill-over effects between regions such that social networks and neighbourhood effects transmit shocks from one region to another.

This behaviour underpins the observations common in OECD economies that clusters of high unemployment regions or hot spots form as a result of spatial interdependency.

Accordingly, public investment is unlikely to benefit the most disadvantaged workers in the economy.

We introduced the Job Guarantee, in part, to explicitly provide opportunities for the most disadvantaged workers.

The Job Guarantee does not rely on the government spending at market prices, and, then exploiting multipliers to achieve full employment.

The latter approach characterises Keynesian pump-priming and as a consequence fails to provide an integrated full employment-price anchor policy framework.

Remember the Job Guarantee is a macroeconomic stability framework which makes it much more than a public sector job creation program.

A Job Guarantee, by definition, is spatially targetted – an unconditional job offer to anyone who wants to work, irrespective of where they live.

Job Guarantee jobs would be designed to support local community development and advance environmental sustainability.

Indeed, an environmental criterion could be used to determine which jobs are acceptable for the Job Guarantee, introducing an environmental planning aspect to the policy framework.

Job Guarantee workers could participate in many community-based, socially beneficial activities that have intergenerational payoffs, including urban renewal projects, community and personal care, and environmental schemes such as reforestation, sand dune stabilisation, and river valley and erosion control.

Most of this labour intensive work requires very little capital equipment and training.

Importantly, I have never held out that the Job Guarantee is the only solution available to government.

While advocates of the generalised expansion approach usually ignore any role for a buffer employment stock policy, which allows the government to guarantee full employment using automatic stabilisers by purchasing at fixed prices, the fact is that both approaches can co- exist.

First, there is a strong role for public infrastructure spending to ensure that communities are well supported with schools, roads, public transport, hospitals, etc…

Second, the Job Guarantee does not replace social security payments to persons unable to work because of age, illness, disability, or parenting and caring responsibilities.

Clearly, and emphatically, a mixture of both approaches is likely to be optimal – however, a generalised expansion alone is not preferred.


Given that, what are the problems of running a flexible buffer stock of jobs when workers can be bid out of the pool on any day by non-government employers?

We considered this question very early on in the development of the Job Guarantee. Indeed, when I first developed the idea of a buffer stock of jobs as an full-employment, inflation control mechanism in my Honours year at the University of Melbourne in 1978, I discussed the idea of a core component and an ephemeral component in the Job Guarantee pool.

So lets briefly consider the issue and how we solve it within MMT.

Instead of forcing workers into unemployment when private (or public) demand slumped, the Job Guarantee would ensure that all those who would, under the current unemployment buffer stock approach to inflation control, become unemployed would have access to a public sector job at the minimum wage (with attendant social wage components, such as child care, transport subsidies, rental assistance, superannuation, etc).

It is clear that this overall aim has implications over the economic cycle and the cyclical nature of Job Guarantee jobs presents an operational design challenge for the administration of such a scheme and the design of the Job Guarantee jobs.

These jobs would have to be productive yet amenable to being created and destroyed in line with the movements of the private economic (spending) cycle.

While challenging this is not an impossible requirement for public policy to meet.

The non-government sector does not have a monopoly on being able to mobilise a diverse range of resources and successfully complete thousands of tasks within a tight and complex schedule.

Note also that the non-government sector scheduling is in some sense much less flexible because it cannot afford to ‘inventory’ workers who are (temporarily) unneeded. Job Guarantee can employ workers even before precise tasks are assigned, helping to smooth transitions.

The government has a choice between creating employment opportunities on an ongoing basis in what we might call the regular public service or via buffer stock jobs (the Job Guarantee).

The question as to which of the two delivery mechanisms should be used to address public needs relates to the whether the service is amenable to the buffer stock model or should be provided on an ongoing basis

First, where services need to be provided on an ongoing basis there may be limited scope for Job Guarantee jobs in these industries.

Therefore, the suitability of these jobs in a buffer stock model, which expands and contracts with the economic cycle, may be limited.

There may still be scope for Job Guarantee employees to perform auxiliary tasks or offer assistance in these industries; however this should not be used as a substitute for an aggregate increase in employment in these industries.

The principle operating is that the Job Guarantee should not displace employment in either the non-government sector (unless it is deemed desirable to eliminate certain jobs altogether) or the usual public sector.

This precludes it from delivering services within the Job Guarantee, which either the market or the state currently deem worthy of delivery.

This means that Job Guarantee services will address needs that are currently not profitable for the private sector to meet (because they are public goods or because potential recipients of the services cannot afford them) and which the state currently considers of such low priority as to not warrant addressing.

This does not preclude Job Guarantee services from meeting considerable unmet need in relation to the natural and social environment and among the least powerful sections of society, particularly if the system is well-engaged at the local grass-roots level, where the market and the state generally are not.

In the Job Guarantee, the buffer stock of jobs is designed to be a fluctuating workforce that expands when the level of non-government sector activity falls and contracts when non-government demand for labour rises.

The cyclical nature of the jobs suggests that in designing the appropriate Job Guarantee jobs the buffer stock should be split into two components:

  • A core component that represents the ‘average’ buffer stock over the typical economic cycle, given government policy settings, trend private spending growth, and a mismatch of labor force characteristics and employer preferences.
  • A transitory component that fluctuates around the core as non-government spending ebbs and flows.

The reality of modern labour markets is that there is a lot of labour force ‘churning’ where most of those who are considered to be officially unemployed transition reasonably quickly out of short-term unemployment.

Some might think that this makes the makes operation of a Job Guarantee program more difficult because of the large fluctuations of short-term unemployed.

We have always considered that this observation should lead one to the opposite conclusion: many of those losing jobs will prefer to undertake full-time search rather than accepting temporary Job Guarantee work.

As we have argued, there is no reason why the Job Guarantee would induce all of those with short-term spells of unemployment into Job Guarantee work.

First, the relatively low pay will act as a disincentive for many job losers.

Second, many skilled workers receive redundancy payouts and enter what we call ‘wait’ unemployment and prefer that state than taking a low-skill job. They anticipate becoming reemployed relatively quickly when the cycle turns up again.

Third, the Job Guarantee could provide, say, up to 6 weeks of pay for full-time job search. The length of job search can be pragmatically and even individually set through consultation with employment counsellors.

Fourth, the fluctuations associated with a typical economic cycle are, in fact, not nearly as large as many economists who do not study this data, would like to believe.

Past work by the MMT team at various times have estimated that the total fluctuation between peak and trough in the Job Guarantee pool would perhaps be in the range of 25 per cent of the pool at a maximum.

In other words, we shouldn’t get carried away in estimating the dynamic range of the Job Guarantee pool relative to the standard labour force categories.

In making these ideas operational, it is clear that modelling can provide a guide to the ‘steady-state’ jobs that would be initially offered under the Job Guarantee scheme. This would be a fairly standard task.

Administrators would then prioritise work allocations from a broad array of community enhancing activities.

In this way, it is unlikely that any important function or service would be terminated abruptly, due to a lack of buffer stock workers, when the non-government demand for labour rises.

Thus, the design and nature of Job Guarantee jobs would reflect the underlying notion of a buffer stock.

This stock would, in turn, have a ‘steady-state’ or core component determined by government macroeconomic policy settings, and a transitory component determined by the vagaries of non-government spending.

In the short-term, the buffer stock would fluctuate with non-government sector activity and workers would move between the two sectors as demand changes.

Longer-term changes in the size of the average buffer stock would reflect discrete changes in government policy.

It is in this context that we argue for the existence of a stable core, which might change slowly and predictably as government policy settings change, and which would allow Job Guarantee administrators to more easily allocate workers to jobs.

Many of these core jobs would be more or less permanent.

More ephemeral Job Guarantee activities could then be designed to ‘switch on’ when private demand declined below trend.

These activities would not be used to deliver outputs that might be required on an ongoing basis, but would still advance community welfare.

For example, Job Guarantee jobs in a particular region might be used to provide regular shopping or gardening services for the frail aged, to support the desire of many older persons to remain in their own homes.

It would not be sensible to make the provision of these services transitory or variable, and they would thus be provided from the core buffer.

Clearly, these services could be reassigned to become ‘mainline public sector’ work if a political shift in thinking occurred.

The structure of these jobs and the remuneration paid would however not be altered as a consequence of this political shift.

Other ‘off-the-shelf’ projects would be undertaken or completed only when the Job Guarantee pool expanded sufficiently.

Conclusion

In Part 2, tomorrow, I will consider the ways in which MMT operationalises the Job Guarantee pool.

That is, what policies does it use to expand and/or contract the pool.

It is much more complex than just hiking (or cutting) taxes.

That is enough for today!

(c) Copyright 2019 William Mitchell. All Rights Reserved.

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One of the on-going myths that mainstream (New Keynesian) economists propagate is that monetary policy (adjusting of interest rates) is an effective way to manage the economic cycle. They claim that central banks can effectively manipulate total spending by adjusting the cost of borrowing to increase output and push up the inflation rate. The empirical experience does not accord with those assertions. Central bankers around the world have been demonstrating how weak monetary policy is in trying to stimulate demand. They have been massively building up their balance sheets through QE to push their inflation rates up without much success. Further, it has been claimed that a sustained period of low interest rates would be inflationary. Well, again the empirical evidence doesn’t support that claim. The evidence supports the Modern Monetary Theory (MMT) preference for fiscal policy over monetary policy. Even though the Reserve Bank of Australia has not pursued a QE program (fiscal policy saved our economy from recession during the GFC), it has persisted with very low historic interest rates. And as yesterday’s latest inflation data from the Australian Bureau of Statistics – Consumer Price Index, Australia – shows, the RBA is struggling to push it inflation rate into the so-called target policy range of 2 to 3 per cent. The data shows that the All Groups CPI grew by 1.9 per cent in the 12 months to September 2018 and the so-called core analytical series – Weighted Median and Trimmed Mean – used by the RBA to assess whether interest rates should shift or not grew by less than that. The most reliable measure of inflationary expectations are flat and below the RBA’s target policy range.

The summary Consumer Price Index results for the September-quarter 2018 are as follows:

  • The All Groups CPI rose by 0.4 per cent and has been steady for the last three quarters.
  • The All Groups CPI rose by 1.9 per cent over the 12 months to the September-quarter 2018, compared to the annualised rise of 2.2 per cent over the 12 months to June-quarter 2018.
  • The Trimmed mean series rose by 0.4 per cent in the September-quarter 2018 (steady) and by 1.8 per cent over the previous year (steady).
  • The Weighted median series rose by 0.3 per cent in the September-quarter 2018 (0.4 per cent in the June-quarter 2018) and by 1.7 per cent over the previous year (steady).

While the Australian debate has not been centred on any QE myths – that is, the Reserve Bank of Australia (RBA) has not engaged in any widespread asset purchases unlike its counterparts in Europe, the UK, Japan, the US – there is still an obsession that inflation is just about to accelerate and this will force the RBA to increase interest rates.

Even though inflation has been benign now for some quarters, the market economists (banks) still think it is about to accelerate and the RBA will be hiking interest rates.

But the reality is quite the opposite.

If anything, the pressure is now on the RBA to reduce interest rates given that their preferred measures (see below) are now consistently below their targetting range (2 to 3 per cent).

What is apparent from yesterday’s inflation figures and the most recent labour market data is that there is plenty of room for further fiscal stimulus to boost growth towards its trend level and reduce unemployment and underemployment.

Trends in inflation

The headline inflation rate increased by 0.4 per cent in the September-quarter 2018 and 1.9 per cent over the 12 months to September (down from 2.2 per cent in the previous quarter).

Inflation has been fairly steady over the 2018 despite a sizeable depreciation in the exchange rate (see below).

The following graph shows the quarterly inflation rate since the March-quarter 2008. There is clearly no breakout trend emerging.

The next graph shows the annual headline inflation rate since the first-quarter 2002. The black line is a simple regression trend line depicting the general tendency. The shaded area is the RBA’s so-called targetting range (but read below for an interpretation).

The trend inflation rate is quite steeply downwards.

Once we take out the so-called ‘volatile’ items (food and fuel), the annual inflation rate is only 1.6 per cent. Well below the RBA’s target range.

Petrol prices rose by more than 5 per cent in September and that will probably impact on the December-quarter figure.

It was claimed when the Labour Force data came out for September that as the unemployment rate had fallen to 5 per cent that wage pressures would start to seep into the inflation figures.

I analysed that argument in this blog post – Australian labour market weaker – no employment growth and participation down (October 18, 2018).

The point is that the lower unemployment rate was not a sign of strength emerging. It was driven by a decline in participation arising from slack employment growth.

The mainstream commentators were completely wrong on that score when the ABS released the data.

Further underemployment remains persistently high and, combined with the poor employment growth, is creating flat wages growth conditions.

There will be no major wages push in the inflation data for the foreseeable future.

What is driving inflation in Australia?

The following bar chart compares the contributions to the quarterly change in the CPI for the September-quarter 2018 (green bars) compared to the June-quarter 2018 (blue bars).

Note that Utilities is a sub-group of Housing.

The ABS say that:

  • The most significant price rises this quarter are international holiday travel and accommodation (+4.3%), domestic holiday travel and accommodation (+2.4%), tobacco (+1.8%) and automotive fuel (+1.4%).
  • The most significant offsetting price falls this quarter are child care (-11.8%) and telecommunications equipment and services (-1.5%).

Under Recreation and culture, the main driver was “international holiday travel and accommodation … The rise in international holiday travel and accommodation is due to the summer peak seasons in Europe and America.”

So even though our currency depreciated steadily over the quarter, Australians still were able to take holidays abroad.

The rise in tobacco prices “is due to the effects of the 12.5% federal excise tax increase” – so a government impost.

And the increase in fuel “is due to continued increases in world oil prices flowing through to consumers.”

So even though the currency has depreciated by 12.1 per cent since February 29, 2018, the ABS report that:

… the tradables component of the All groups CPI rose 0.1% and the non-tradables component rose 0.2%.

This tells you something about the extent of exchange rate pass through effects and the likelihood in a small, open economy exporting primary commodities, that a depreciating exchange rate will be highly inflationary. In Australia’s case, that probability is low.

The next graph provides shows the contributions in points to the annual inflation rate by the various components.

In the twelve months to the end of September 2018, the major drivers of inflation were Housing (energy), Transport (petrol), and Alcohol and Tobacco Prices (government policy).

Inflation and Expected Inflation

I mentioned at the outset, the on-going inflation obsession among market players.

If you examine the market trends in speculative trades then it is clear that the traders were betting on a major shift in the RBA policy upwards after 2016 because they have been punting on a substantial rise in inflation.

They have been systematically wrong on that front.

More recently, it is clear their expectations have been falling as the RBA holds to its low interest rate regime.

Significantly, it is this misplaced fear of inflation, that, in place, drives the misplaced preference by New Keynesians for counter-stabilising monetary policy instead of fiscal policy.

If we went back to 2009 and examined all of the commentary from the so-called experts we would find an overwhelming emphasis on the so-called inflation risk arising from the fiscal stimulus. The predictions of rising inflation and interest rates dominated the policy discussions.

The fact is that there was no basis for those predictions in 2009 and nine years later no major inflation outbreak is forthcoming.

The following graph shows four measures of expected inflation expectations produced by the RBA – Inflation Expectations – G3 – from the June-quarter 2005 to the September-quarter 2018.

The four measures are:

1. Market economists’ inflation expectations – 1-year ahead.

2. Market economists’ inflation expectations – 2-year ahead – so what they think inflation will be in 2 years time.

3. Break-even 10-year inflation rate – The average annual inflation rate implied by the difference between 10-year nominal bond yield and 10-year inflation indexed bond yield. This is a measure of the market sentiment to inflation risk.

4. Union officials’ inflation expectations – 2-year ahead.

Notwithstanding the systematic errors in the forecasts, the price expectations (as measured by these series) are trending down in Australia, which will influence a host of other nominal aggregates such as wage demands and price margins.

The market economists’ one-year and two-year ahead expectations are well above the Break-even 10-year inflation rate. Even Union officials have fallen for the accelerating inflation outlook.

It is well known that the ‘market economists’ systematically get movements in the economy wrong and one wonders if their organisations actually bet money on their analysis!

The most reliable measure – the Break-even 10-year inflation rate – is now at 1.9 per cent, well below the lower bound of the RBA targetting range but spot on where the actual raw inflation rate came in at.

It has been at or below the lower bound of the RBA’s policy target range since March 2016.

The other expectations are still lagging behind the actual inflation rate, which means that forecasters progressively catch up to their previous forecast errors rather than instantaneously adjust, a further piece of evidence that refutes the mainstream economics hypothesis that decision makers use ‘rational expectations’ (that is, on average get it right).

Implications for monetary policy

What does this all mean for monetary policy?

Clearly, the market economists were punting on a rise in the interest rate and have only started to realise in the last few quarters that this is unlikely to happen any time soon (as disclosed by their inflationary expectations above).

The inflation trends highlighted in yesterday’s data release provide no basis for any expectation that the RBA will hike interest rates anytime soon.

In fact, if anything, the pressure is now on the RBA to cut rates again.

The Consumer Price Index (CPI) is designed to reflect a broad basket of goods and services (the ‘regimen’) which are representative of the cost of living. You can learn more about the CPI regimen HERE.

Please read my blog – Australian inflation trending down – lower oil prices and subdued economy – for a detailed discussion about the use of the headline rate of inflation and other analytical inflation measures.

The RBA’s formal inflation targeting rule aims to keep annual inflation rate (measured by the consumer price index) between 2 and 3 per cent over the medium term. Their so-called ‘forward-looking’ agenda is not clear – what time period etc – so it is difficult to be precise in relating the ABS data to the RBA thinking.

What we do know is that they do not rely on the ‘headline’ inflation rate. Instead, they use two measures of underlying inflation which attempt to net out the most volatile price movements.

To understand the difference between the headline rate and other non-volatile measures of inflation, you might like to read the March 2010 RBA Bulletin which contains an interesting article – Measures of Underlying Inflation. That article explains the different inflation measures the RBA considers and the logic behind them.

The concept of underlying inflation is an attempt to separate the trend (“the persistent component of inflation) from the short-term fluctuations in prices. The main source of short-term ‘noise’ comes from “fluctuations in commodity markets and agricultural conditions, policy changes, or seasonal or infrequent price resetting”.

The RBA uses several different measures of underlying inflation which are generally categorised as ‘exclusion-based measures’ and ‘trimmed-mean measures’.

So, you can exclude “a particular set of volatile items – namely fruit, vegetables and automotive fuel” to get a better picture of the “persistent inflation pressures in the economy”. The main weaknesses with this method is that there can be “large temporary movements in components of the CPI that are not excluded” and volatile components can still be trending up (as in energy prices) or down.

The alternative trimmed-mean measures are popular among central bankers.

The authors say:

The trimmed-mean rate of inflation is defined as the average rate of inflation after “trimming” away a certain percentage of the distribution of price changes at both ends of that distribution. These measures are calculated by ordering the seasonally adjusted price changes for all CPI components in any period from lowest to highest, trimming away those that lie at the two outer edges of the distribution of price changes for that period, and then calculating an average inflation rate from the remaining set of price changes.

So you get some measure of central tendency not by exclusion but by giving lower weighting to volatile elements. Two trimmed measures are used by the RBA: (a) “the 15 per cent trimmed mean (which trims away the 15 per cent of items with both the smallest and largest price changes)”; and (b) “the weighted median (which is the price change at the 50th percentile by weight of the distribution of price changes)”.

Please read my blog – Australian inflation trending down – lower oil prices and subdued economy – for a more detailed discussion.

So what has been happening with these different measures?

The following graph shows the three main inflation series published by the ABS since the March-quarter 2009 – the annual percentage change in the All items CPI (blue line); the annual changes in the weighted median (green line) and the trimmed mean (red line).

The RBAs inflation targetting band is 2 to 3 per cent (shaded area). The data is seasonally-adjusted.

The three measures are all currently below the RBA’s targetting range:

1. CPI measure of inflation – 1.9 per cent and below the RBAs target band for the last two years.

2. The RBAs preferred measures – the Trimmed Mean (1.8 per cent and stable) and the Weighted Median (1.7 per cent and stable) – are also below the lower bound of the RBAs targetting range of 2 to 3 per cent.

How to we assess these results?

First, despite the depreciating Australian dollar since February, there is clearly no pressures coming from the traded-goods sector to push the inflation rate above the target range.

Second, there is clearly a downward trend in all of the measures. The “core” measures used by the RBA have been benign for many quarters even with an on-going significant fiscal deficit and record low interest rates.

Third, the RBA will also be mindful that real GDP growth is still below trend and the labour market is still in an uncertain-to-vulnerable state, with broad labour underutilisation still above 13 per cent (or more).

In terms of their legislative obligations to maintain full employment and price stability, one would think the RBA would have to cut interest rates in the coming month given the state of the economy and the benign inflation environment.

Further, as I have noted elsewhere, wages growth is flat and at record lows.

Fourth, inflationary expectations are benign and trending downwards.

My view is that the RBA should cut rates now that all three measures have been consistently below the targetting range.

Conclusion

Just before the GFC hit all the macroeconomic policy talk in Australia was about getting deficits down and into surplus to ensure that inflation didn’t accelerate.

It was nonsensical talk even then, when economic growth was stronger and unemployment lower.

The doomsayers were completely wrong when they predicted the fiscal stimulus in 2008-09 would generate dangerous inflation impulses.

The trend has been down for some years now and some nations are fighting deflation rather than inflation.

Australia is now a member of the low-inflation brigade despite GDP growth continuing (albeit below trend) and the exchange rate depreciating significantly over the course of this year.

Interest rates remain low and even the bank economists are starting to revise their inflationary expectations downwards as they realise the predictions coming out of mainstream macroeconomic models are useless.

That is enough for today!

(c) Copyright 2018 William Mitchell. All Rights Reserved.

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I am surprised at the hostility that Part 1 in this series created. I have received a lot of E-mails about it, many of which contained just a few words, the most recurring being Turkey! One character obviously needed to improve his/her spelling given that they thought it was appropriate to write along the lines that I should just ‘F*ck off to Terkey’. Apparently Turkey has become the new poster child to ‘prove’ Modern Monetary Theory (MMT) wrong. Good try! I also note the Twitterverse has been alight with attention seekers berating me for daring to comment on the sort of advice British Labour is receiving. Well here is Part 2. And because you all liked it so much, the series has been extended into a three-part series because there is a lot of detail to work through. Today, I revisit the fiscal rule issue, which is a necessary step in refuting the claim that MMT policy prescriptions (whatever they might be) will drive the British pound into worthless oblivion. And, you know what? If you don’t like what I write and make available publicly without charge, then you have an easy option – don’t read it. How easy is that? Today, I confirm that despite attempts by some to reconstruct Labour’s Fiscal Rule as being the exemplar of progressive policy making, its roots are core neoclassical economics (which in popular parlance makes it neoliberal) and it creates a dependence on an ever increasing accumulation of private debt to sustain growth. Far from solving a non-existent ‘deficit-bias’ it creates a private debt bias. Not something a Labour government or any progressive government should aspire to.

As background, I have discussed some of these issues in great detail in previous blog posts (including):

1. British Labour Party is mad to sign up to the ‘Charter of Budget Responsibility’ (September 28, 2015).

2. The non-austerity British Labour party and reality – Part 2 (September 29, 2015).

3. The full employment fiscal deficit condition (April 13, 2011).

4. Seeking zero fiscal deficits is not a progressive endeavour (June 18, 2015).

5. Jeremy Corbyn’s ‘New Politics’ must not include lying about fiscal deficits (September 15, 2015).

6. British Labour has to break out of the neo-liberal ‘cost’ framing trap (April 12, 2017).

7. British labour lost in a neo-liberal haze (May 4, 2017).

8. When neoliberals masquerade as progressives (November 9, 2017).

9. The lame progressive obsession with meaningless aggregates (November 23, 2017).

10. The New Keynesian fiscal rules that mislead British Labour – Part 1 (February 27, 2018).

11. The New Keynesian fiscal rules that mislead British Labour – Part 2 (February 28, 2018).

12. The New Keynesian fiscal rules that mislead British Labour – Part 3 (March 1, 2018).

I provide links to previous blog posts I have written for two reasons: (a) to avoid detailed repetition; and (b) to help people navigate through related issues on what is now a rather complex body of writing.

Britain Labour’s fiscal rule

When John McDonnell presented his first major speech on what the Labour Party might do there was an outcry among those sympathetic to Modern Monetary Theory (MMT) who saw it as a harbinger for austerity.

The mainstream press also reacted viscerally with the UK Guardian, for example, publishing the commentary (September 26, 2015) – John McDonnell: Labour will match Osborne and live within our means – which predicted the worst.

In his – Speech by John McDonnell to Labour Party Annual Conference (September 29, 2015) – the Shadow Chancellor said that:

Austerity is not an economic necessity, it’s a political choice … We will tackle the deficit fairly and we can do it … Labour’s plan to balance the books will be aggressive … Where money needs to be raised it will be raised from fairer, more progressive taxation.

So in this framing, the Labour Party was signalling that it would continue to construct the macroeconomic debate within the standard neoliberal (mainstream economics) framework. The language and concepts of that flawed approach would be retained.

At the time, I wrote that if we consider what John McDonnell said carefully, it may not be as bad as, for example, the Guardian headlines suggested.

I also wrote that McDonnell’s speech disclosed a deep insecurity in the Corbyn camp that leaves them adopting fiscal rules, which are in essence the DNA of neo-liberals.

The Speech retained the focus on the fiscal balance as if it was the priority, notwithstanding his decomposition into current and capital components.

One would have hoped, that a progressive political force would have, instead, endeavoured to shift the focus onto creating full employment and prosperity rather than maintaining the focus on meaningless fiscal ratios.

I also wrote at the time that the adoption of the Tory fiscal rule – the so-called – Charter of Budget Responsibility – would still provide Labour with some flexibility for government to avoid harsh austerity.

But, the maintenance of a commitment to the Charter could easily become a source of unnecessary rigidity, which under certain (not unusual circumstances) would prevent a Labour government from fulfilling its responsibilities to advance welfare.

In particular, the debt commitment was likely to give political grief if the future Labour government tried to stick to it.

Notwithstanding my comments above, I have read some rather amazing interpretations of Labour’s fiscal rule in the last week.

In response to criticisms from some social media participants that the rule was a neoliberal construct, one of those involved in the design of the rule had the temerity to claim that in actual fact the rule is an exemplar of progressive policy design.

Spare me!

Lets first of all understand exactly what the rule is.

The official British Labour Party document outlining the rule – Labour’s Fiscal Credibility Rule – tells us that, in government, British Labour will:

1. “close the deficit on day-to-day spending over five years” by matching spending with tax revenue.

2. “make sure government debt is falling at the end of five years”.

3. “will borrow only to invest”.

All of this is neoliberal central.

But it is important to understand that this doesn’t negate on-going fiscal deficits. It just means that so-called recurrent (or current) spending must be matched by tax revenue over a five-year period.

So an application of the rule will also not stop a fiscal deficit on recurrent spending in say year 1 of a new Parliamentary term either. It just means that over a rolling five-year horizon the balance has to be zero.

But that restriction is not only unnecessary but also probably not manageable given timing issues.

In effect, John McDonnell is proposing Labour will adopt the so-called ‘Golden Rule’, a concept I will come back to presently.

There were also some operational guidelines accompanying this balanced fiscal rule.

First:

When the Monetary Policy Committee decides that monetary policy cannot operate (the “zero-lower bound”), the Rule as a whole is suspended so that fiscal policy can support the economy. Only the MPC can make this decision.

Things to note from this constraint, which reinforce the neoliberal roots of the Rule:

1. An unelected and largely unaccountable central bank thus runs economic policy in that it instructs the democratically-elected government when it can use its fiscal capacity.

2. It appears that this would occur when the Bank of England judges it is at the so-called “zero-lower bound”, which means nominal interest rates cannot go any lower.

A “zero-lower bound” probably also includes a period of very low interest rates.

But, as I explain below, this constraint sits squarely with the dominant New Keynesian view that monetary policy is always the preferred counter-stabilisation option (as opposed to fiscal policy) and fiscal policy will only be used as a counter-stabilising force when monetary policy ceases to have traction (zero-bound).

Begging the question, of course, is whether monetary policy is effective at any interest rate range.

While elevating monetary policy above fiscal policy suited the ideological agenda of ‘small’ government and an increasingly deregulated and unsupervised economy, the evidence would suggest that this reliance on monetary policy has not delivered satisfactory outcomes.

I deal with that issue below.

Second, the unelected and unaccountable Office for Budget Responsibility would no longer report to Treasury under Labour. Rather, it would report directly to Parliament.

The OBR produces so-called ‘independent’ forecasts of the British economy and the ‘state’ of government finances on a regular basis, which ‘condition’ the political debate.

A government can hardly go against the forecasts in any meaningful way unless it wants to face claims that it is ignoring so-called ‘experts’.

The ‘independence’ assumption is, of course, loaded because first of all the senior positions in OBR are determined by the Treasury Committee, which is a political construct.

And the professional positions within the OBR will be drawn from the mainstream economics profession and so the frameworks for analysis (and forecasting) will reflect the dominant neoliberal bias of that profession.

Thus, if we stack a ‘fiscal council’ with mainstream economists we don’t get ‘independent’ analysis. We get Groupthink. Just look at the track record of the IMF.

So the OBR is certainly not independent in an ideological sense, given that the dominant paradigm in macroeconomics is firmly neoliberal, despite some trying to claim otherwise.

Further, like the IMF and other similar organisations, the OBR regularly produces systematic forecasting errors, which are overlooked because their inputs into the public debate are privileged by their status. The semblance of ‘expertise’ gives the OBR an authority that their output record doesn’t warrant.

Sometimes I think that people have become so inured to the shifts that have occurred under the neoliberal era that they forget context and live in a totally fictional concept of normality.

So heartland neoliberal characteristics become ‘normality’ – progressive even! That is how far the Left has become captive to these ideological constructs.

In the current context, the standard neoliberal line deems that key economic policy decisions should be taken out of the political process and the discretionary judgement of elected politicians, and, instead, the responsibility should be vested in so-called ‘independent institutions’.

In our latest book – Reclaiming the State: A Progressive Vision of Sovereignty for a Post-Neoliberal World (Pluto Books, September 2017), we examine the concept of depoliticisation in some detail.

The faux concept of central bank independence was the first step in this retrogression away from democracy. This concept came straight out of Monetarism and Milton Friedman’s initial attacks on policy discretion and the need for policy rules.

Please read my blog posts (among others) for more discussion on this issue:

1. The sham of central bank independence (December 23, 2014).

2. The consolidated government – treasury and central bank (August 20, 2010).

3. Central bank independence – another faux agenda (May 26, 2010).

Friedman used this ruse to recommend that central banks should just follow a monetary growth rule.

The Bank of England was the first central bank to adopt this approach in the early 1970s and abandoned the approach shortly afterwards because they soon learned that a central bank in a monetary economy cannot ‘control’ the money supply.

The fact that Monetarism continued to gain acceptance and become the dominant paradigm is amazing when we consider one of its fundamental precepts – the ability of the central bank to control broad money – was shown to be impossible.

It was, in fact, a triumph of the embedded ideology over substance. Which really was the point all along.

The Monetarist attack on discretionary policy was intensified with the publication of the work of Finn Kydland and Edward Prescott (1977) who distinguished between ‘time-inconsistent’ and ‘time-consistent’ policy.

They claimed that a time-inconsistent policy would be popular in the short-term but would fail to achieve its long-term objectives, whereas the opposite is the case for time-consistent policies.

An example they would use relates to central banks who have a charter to maintain price stability but realise that there might be some costs in higher unemployment (according to the Phillips curve tradeoff).

The central bank makes its decisions in the knowledge that the public form their future behaviour, in part, based on rational expectations of policy settings.

So they announce that they will maintain policy settings that exclusively focus on the retention of a low inflation rate, by hook or by crook.

This is claimed to shape the expectations that people form so that they expect low inflation and behave accordingly (in their price and wage setting decisions), which reinforces the policy target.

But Kydland and Prescott claimed that that alone would not be credible because people would soon work out that the central bank would relent on its ‘low inflation’ policy and introduce expansionary monetary policy in order to reduce unemployment.

They claimed that people work this out straight away because they are assumed the know the true economic model (by dint of the rational expectations assumption).

As result, they ignore the central bank statements and act as if inflation will worsen. In doing so, they make decisions that lead to higher inflation.

Accordingly, the solution to this problem, was that discretion of monetary policy makers had to be eliminated by a rule that cannot be easily changed.

This is the essence of the ‘central bank independence’ narrative.

Proponents claim that the imposition of the rule would establish credibility among rational people who would then deliver low inflation through their behaviour.

The rub is, of course, that this monetary rule would probably lead to higher unemployment and output losses.

But they assumed those losses away as, at worst, short-term adjustments as expectations adjusted to a lower inflation environment.

Once expectations, the NAIRU (the neoliberal full employment concept) would be asserted via the market and so there was no need to be concerned about the initial rise in unemployment.

In other words, the mantra was (and is) that the central bank if left to pursue an inflation target and not worry about other policy targets, will deliver full employment anyway.

So what is there not to like?

Answer: plenty!

But be under no false impression – British ‘Labour’s Fiscal Credibility Rule’ is a product of these developments and attempts to cast it as progressive are just in denial of the roots of the ideas underlying the Rule.

The whole modern meaning of credibility in economics comes out of this mainstream economics literature and rely on a number of assumptions that defy reality.

For example, the assumption of rational expectations is unsustainable. Please read my blog post – The myth of rational expectations (July 21, 2010) – for a detailed discussion.

Further, the idea that central banks should be independent of the political process was a key part of the emerging neoliberal agenda and the claim that governments could not permanently reduce mass unemployment using fiscal policy.

The central bank independence push was based on the Monetarist claims that it was the politicisation of the central banks that prolonged the inflation (by “accommodating” it).

The arguments claimed that central bankers would prioritise attention on real output growth and unemployment rather than inflation and in doing so cause inflation – as in ‘time-inconsistent’ policies (above).

The Rational Expectations (RATEX) literature which evolved at that time then reinforced this view by arguing that people (you and me) anticipate everything the central bank is going to do and render it neutral in real terms but lethal in nominal terms.

In other words, they cannot (permanently) increase real output with monetary stimulus but will always cause accelerating inflation if they try.

There were variations on the theme, with some New Keynesians claiming that there could be short-run output gains and declines in unemployment, but these would be wiped out over time as expectations adjusted.

So the message was that in the extreme version – do not use fiscal policy to try to steer aggregate spending at all – and in the less extreme version – balance the fiscal state over a cycle and never use the currency-issuing capacity to cover deficits.

But underlying the notion was a re-prioritisation of policy targets – towards inflation control and away from broader goals like full employment and real output growth.

Indeed, whereas previously unemployment had been a central policy target, it became a policy tool in the fight against inflation under this new approach to monetary policy.

Accordingly, mainstream economists claimed that the only way the government could permanently reduce unemployment if they thought the current level was too high was via supply-side policies – deregulation, withdrawal of income support, etc.

The ‘free market’ agenda.

During the GFC we saw the venality of this reasoning, when, for example, the European Commission claimed that the steady-state (natural) rate of unemployment in Spain had risen to around 24 or so per cent, when prior to the crisis it was well below 10 per cent.

The ‘independence’ argument is always clothed in authoritative statements about the optimal mix of price stability and maximum real output growth and supported by heavy (for economists) mathematical models.

If you understand this literature you soon realise that it is an ideological front.

The models are not useful in describing the real world – they have little credible empirical content and are designed to hide the fact that the proponents do not want governments to do what we elect them to do – that is, advance general welfare.

Recall, that the main New Keynesian model didn’t even have a financial sector embedded in it. But still they made these claims.

This is neoliberal central.

In this blog post – Central bank independence – another faux agenda (May 26, 2010) – I provide a lot more detailed discussion.

Further, when you study the inflation targetting literature you find that the claims about its effectiveness in disciplining inflation are grossly exaggerated.

As I explain in this blog post – Inflation targeting spells bad fiscal policy (October 15, 2009) – the evidence is clear – inflation targeting countries have failed to achieve superior outcomes in terms of output growth, inflation variability and output variability; moreover there is no evidence that inflation targeting has reduced inflation persistence.

But the emphasis on monetary policy is consistent with the dominant themes in this neo-liberal era – that fiscal policy should be passive and monetary policy should be the primary counter-stabilisation tool.

Further, what about the claim that by forcing a rule-driven central bank to concentrate exclusively on inflation control, the economy naturally produces full employment?

A second’s thought should tell you that if accelerating inflation reflects cost-push and distributional conflict factors, such an approach will always require higher unemployment to reduce these pressures.

Further, the result of this approach has been elevated and persistent unemployment rates in most nations.

The sacrifice ratio concept is used to measure of the costs of monetary policy disinflation strategies, which characterise the inflation-targetting era.

Some years ago I did a lot of work estimating sacrifice ratios for various nations. There is a detailed discussion of this work in my 2008 book with Joan Muysken – Full Employment abandoned.

The concept is easy to understand.

The sacrifice ratio is defined as the cumulative loss of output during a disinflation episode as a percentage of initial output divided by the reduction in the trend inflation rate.

So, if we calculated a sacrifice ratio equal to 3, this can be interpreted as saying that a one percentage point reduction in trend inflation is accompanied by a 3 per cent loss of output (measured from the most recent peak).

There is a vast literature on the estimation of sacrifice ratios which typically find that disinflations are not costless and, are in fact, significantly damaging.

The fact is that the estimates of sacrifice ratios for Britain were low in the 1970s but have risen significantly in the neoliberal period when central banks started to ‘fight inflation first’.

I consider that issue in this blog post – Inflation targeting spells bad fiscal policy (October 15, 2009).

The passivity of fiscal policy proved very costly as unemployment persisted at elevated levels.

So the New Keynesian emphasis on the primacy of monetary policy over fiscal policy is not a reflection of what is the most efficient way to deliver macroeconomic stability.

The GFC was a manifestation of how this approach fails to deliver stability and produces massive real resource wastage.

And the GFC also taught us another thing.

Unlike the standard claims by New Keynesians that fiscal policy was an ineffective counter-stabilisation tool and monetary policy was to be preferred, the GFC proved beyond doubt that monetary policy is incapable of arresting a major collapse in non-government spending and incapable of actually generating accelerating inflation.

Fiscal policy..

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