Scott T. Fullwiler

Macroeconomic Stabilization Through an Employer of Last Resort

The employer of last resort (ELR) policy proposal, also referred to as the job guarantee or public sector employment, is promoted by its supporters as an alternative to unemployment as the primary means of currency stability. The core of the ELR proposal is that a job would be provided to all who wanted one at a decent, fixed wage; the quantity of workers employed in the program would be allowed to rise and fall counter to the economy’s cycles as some of the workers moved from public to private sector work or vice versa depending upon the state of the economy. Supporters have played an important advisory role in Argentina’s Jefes de Hogar jobs program that has provided jobs to over two million citizens – or five percent of the population; though there are some important differences, the Jefes program has many similarities with the ELR proposal (Tcherneva and Wray 2005). While ELR proponents argue the program would not necessarily generate budget deficits (Mitchell and Wray 2004), the program is based upon Abba Lerner’s (1943) concept of functional finance in which it is the results of the government’s spending and taxing policies in terms of their effects upon employment, inflation, and macroeconomic stability that matter (Nell and Forstater 2003). This is in contrast to the more widely promoted concept of “sound” finance, in which the presence of a fiscal deficit is itself considered undesirable. Rather than not being able to “afford” an ELR program, ELR proponents argue that societies would do better to consider whether they can “afford” involuntary unemployment. The proposed ELR’s approach of hiring “off the bottom” is argued to be a more direct means for eliminating excess, unused labor capacity than traditional “military Keynesianism” or primarily “pump-priming” fiscal policies, particularly given how the U.S. economy struggles to create jobs for the poor even during economic expansions (Pigeon and Wray 1998, 1999; Bell and Wray 2004). As Wray (2000) notes, “How many missiles would the government have to order before a job trickles down to Harlem?”. More traditional forms of fiscal stimulus or stabilization are still useful and complementary to an ELR program, though proponents argue that only the latter could ensure that enough jobs would be available at all times such that every person desiring a job would be offered one while also potentially adding to the national output.Regarding macroeconomic stability, it is the fluctuating buffer stock of ELR workers and the fixed wage that are argued by proponents to be the key features that ensure the program’s impact would be stabilizing. With an effectively functioning buffer stock, the argument goes, as the economy expands ELR spending will stop growing or even decline – countering the inflation pressures normally induced by expansion – as some ELR workers take jobs in the private sector. Regarding the fixed wage, traditional government expenditures effectively set a quantity and allow markets to set a price (as in contracting for weapons); in contrast, the ELR program allows markets to set the quantity as the government provides an infinitely elastic demand for labor, while the price (the ELR base wage) is set exogenously and is unaffected by market pressures. Together, proponents argue, the buffer stock of ELR workers and the fixed wage thereby encourage loose labor markets even at full employment. Aside from an initial increase as the program is being implemented (the size of which will depend upon the wage offered compared to the existing lowest wage and whether the program is made available to all workers), proponents suggest the program would not generate inflationary pressures and thus would promote both full employment and price stability. The purpose of this paper is to model quantitatively the potential macroeconomic stabilization properties of an ELR program utilizing the Fairmodel (Fair 1994, 2004). The paper builds upon the earlier Fairmodel simulations of the ELR in Majewski and Nell (2000) and Fullwiler (2003, 2005). Here, a rather simple version of the ELR program is incorporated into the Fairmodel and simulated. The quantitative effects of the ELR program within the Fairmodel are measured via simulation within historical business cycles and in comparison to other policy rules for both fiscal and monetary policies through stochastic simulation.

Timeliness and the Fed's Daily Tactics

Recognizing that analysis of the daily activities have recently become a standard part of the monetary economics literature, this paper provides a detailed description of the Fed’s daily tactics from an institutionalist perspective. The three relevant categories of time in the Fed’s daily operations — daily, maintenance period, and seasonal — are described within the context of the institutional working rules giving rise to each category. This framework is used to explain recent events in monetary policy implementation. The final section of the paper illustrates how the discussion of time and timeliness in the Fed’s daily tactics can be used to inform research on traditional topics in monetary economics and argues that (1) the payments system, rather than reserve requirements, is the proper starting point for analysis of the Fed’s daily tactics; (2) there is no liquidity effect in the federal funds market; and (3) direct control over the monetary base is not possible.

Interest Rates and Fiscal Sustainability

As baby boomers reach retirement age, concerns over the future path of federal spending on entitlement programs grow among orthodox economists. Researchers closely tied to the “generational accounting” literature (i.e., Kotlikoff 1992) have been particularly prominent here. These economists have developed a measure that they call the “fiscal imbalance” – which they claim measures the magnitude of an existing unsustainable fiscal path. They argue that the fiscal path of the U.S. is

Paying Interest on Reserve Balances: It's More Significant than You Think

44 trillion off course compared to a “sustainable” path (Gokhale and Smetters 2003a). Others within the circle have noted the

Modern Central Bank Operations – The General Principles

44 trillion “fiscal imbalance” in numerous opinion pieces (e.g., Gokhale and Smetters 2003b; Kotlikoff and Sachs 2003) and in other publications (e.g., Ferguson and Kotlikoff 2003; Kotlikoff and Burns 2004). An essentially identical measure expressing the imbalance as a percent of future GDP shows it to be about 7 percent (e.g., Auerbach et al. 2003). The “fiscal imbalance” is calculated as the current national debt plus the present value of future expenditures less the present value of future revenues; future expenditures and revenues are estimated or predicted to the infinite horizon (Gokhale and Smetters 2003a; Auerbach et al. 2003). The widely-cited 2003 study by Jagadeesh Gokhale and Kent Smetters was originally commissioned by then-Treasury Secretary Paul O’Neill in 2002, when its authors were deputy assistant secretary for economic policy at the Treasury (Smetters) and consultant to the Treasury (Gokhale), respectively. However, the Bush Administration played down the results of the report as it prepared in late 2002 and early 2003 to promote a second round of tax cuts (Despeignes 2003). Nonetheless, measuring a “fiscal imbalance” via an identical methodology has since been promoted by others in the Office of Management and the Budget (2005), the Treasury (e.g., Fisher 2003), the IMF (e.g., Muhleisen and Towe 2004), and has also been incorporated into projections of the Trustees for Social Security and Medicare. A final example is worth particular mention: in November 2003, Democratic Senator Joseph Lieberman introduced the “Honest Government Accounting Act” that declared “the most appropriate way to assess Government finances is to calculate its net assets under current policies: the net present value of all prospective receipts minus the net present value of all prospective outlays and minus outstanding debt held by the public.” The proposed Act specifically mentioned the study by Gokhale and Smetters and held it as an example of “honest government accounting.” Had it been passed into law, the legislation would have created a “commission on long-term liabilities and commitments” to calculate the federal government’s “fiscal imbalance” at 75-year and infinite horizons; had the “fiscal imbalance” been determined to exceed pre-set limits in any given year, the President would have been required to submit a plan for reducing the imbalance. In addition, all proposals for increased future spending or reductions in taxes would have been required to be “fiscally balanced” at 75-year and infinite horizons.These examples are the most recently influential applications of one of the core themes of orthodox macroeconomics: fiscal sustainability. Indeed, most will recognize that fiscal sustainability as presented in the fiscal imbalance literature is essentially an application of the orthodox concept of a government’s intertemporal budget “constraint.” Consequently, this paper is not as concerned about the particulars of the “fiscal imbalance” or related “generational accounting” literatures; nor, for that matter, does it deal directly with the supposedly looming financial “crises” facing Social Security or Medicare. Instead, the paper is most concerned with understanding and critiquing the assumptions or beliefs at the core of these literatures and measures, and then with providing an alternative view. Fiscal sustainability, when defined via an intertemporal budget “constraint” as the “fiscal imbalance” literature does, relies heavily upon assumptions regarding the relative rate of interest paid on the national debt. Several heterodox economists, particularly Post Keynesians such as Arestis and Sawyer (2003), have also noted this fact. This paper expands upon heterodox research in this area by referencing the actual operations of the Federal Reserve (hereafter, the Fed) and the Treasury as set out in their own research and regulatory publications and as consistent with their own balance sheet operations. In short, the orthodox concept of fiscal sustainability is flawed due to its assumption that a key variable – the interest rate paid on the national debt – is set in private financial markets as in the orthodox loanable funds framework. On the contrary, as a modern or sovereign money (Wray 1998, 2003) system operating under flexible exchange rates, interest rates on the U.S. national debt are a matter of political economy (Fullwiler 2006). This has significant implications for the appropriate “mix” of monetary and fiscal policies, particularly if full employment and financial stability are considered fundamental goals of macroeconomic policy that can be enhanced by appropriate fiscal policy actions.

Modern Money Theory: A Response to Critics

It has long been recognized that uncompensated reserve balances act like a tax on banks and that banks as a result expend scarce resources to avoid holding them. The Fed itself has historically supported legislation to enable it to pay interest on reserve balances (e.g., Kohn 2003), as have economists (e.g., Goodfriend 2002), both for reasons of economic efficiency and to improve the implementation of monetary policy. The traditional argument against interest payment has been that it would reduce the Fed’s earnings that are subsequently turned over to the Treasury (Feinman 1993b; Abernathy 2003). The purpose of this paper is to demonstrate the implications of paying interest on reserve balances on the daily operations of both the Fed and the Treasury. While the arguments here - for different reasons - generally are in favor of enabling the Fed to pay interest on reserve balances, more important than the actual payment of such interest is the perspective gained when considering in detail the operations of both in an environment where reserve balances earn interest.

The Social Fabric Matrix Approach to Central Bank Operations- An Application to the Federal Reserve and the Recent Financial Crisis

The debates between the structuralists and horizontalists within Post Keynesian economics highlighted the fact that endogenous money proponents had a very different understanding of monetary operations than did neoclassical economists. Indeed, as Fullwiler (2003) reports, until recently, research among neoclassicals related to bank behavior in the U. S. federal funds market had little relation to research on the Fed’s behavior, and vice versa, aside from a few notable exceptions. This has all changed considerably since the late 1990s, as neoclassical researchers found several issues that required bringing the two together—such as concerns about policy options at the zero bound, retail sweep accounts, payments system crises, and increased use of non-central bank wholesale settlement options. Whereas a detailed understanding of monetary operations has been central to research in the endogenous money tradition for decades now, it is not a stretch to suggest that it is now also a well-established area of research within neoclassical monetary economics. There are sharp differences between the two approaches that nonetheless remain. Among neoclassicals, the literature on central bank operations is not integrated into models of financial asset pricing or into the so-called “new consensus” model of the economy. Though the latter assumes interest-rate targeting, new consensus models are concerned with the strategy of monetary policy,

An Endogenous Money Perspective on the Post-Crisis Monetary Policy Debate

Over the past two decades a group of us has developed an alternative approach to monetary theory that integrates the insights of Knapp’s (1924) state money approach (also called chartalist and adopted by Keynes (1930, 1914)), the credit money view of Innes (1913, 1914), Lerner’s (1943, 1947) functional finance approach, Minsky’s (1986) views of banking, and Godley’s (1996) sectoral balance approach. In addition, most of us have used our understanding of the operation of the monetary system to propose an employer of last resort or job guarantee program to provide an anchor to the value of the currency. The approach has come to be known as modern money theory (MMT) and has been widely debated and adopted, especially on the blogosphere. Prominent economists such as Paul Krugman and Brad Delong have taken notice and deemed it to be a theory of note, even if they do not accept all of it. Further, developers of MMT have been credited with foreseeing the global financial collapse as well as the troubles with the Euro as early as the 1990s (Wray 1998, Bell 2003). Still, MMT has always had its critics. Somewhat surprisingly to us, some of the most vocal critics have been heterodox economists, particularly the Post Keynesians. We see nothing in the MMT approach that should be difficult for PKs to accept. Yet, in recent weeks both Marc Lavoie and Bret Fiebiger have provided critiques. It looks to us as if they have not understood our arguments. Instead of providing a point-by-point response to either of their papers, we think it will be more useful to briefly lay-out our main argument in a way that should be accessible to PKs. We have been given only 4000 words for this task, hence, we can only hit the main points. More specifically, this response will in turn discuss the role of endogenous money and the circuit for MMT, the MMT understanding of government debt operations, and the links between the MMT approach and heterodoxy in general.

The Social Fabric Matrix Approach to Policy Analysis: An Introduction

This chapter utilizes the social fabric matrix approach (SFM-A) to provide a detailed description of the Federal Reserve’s (Fed’s) daily operations and the recent financial crisis. The SFM of the Fed’s operations presents the primary components – major norms, institutions, technologies – relevant on a day-to-day basis. The SFM is then used for normative systems analysis (Hayden 1998) to show the articulation of major norms via sub-criteria, rules, regulations, and requirements into significant influences on the actions of authorizing and processing institutions in the Fed’s operations. From the normative systems analysis, three types of time – intraday, maintenance period, and seasonal – in the Fed’s daily operations can be explained. Overall, the Fed’s operations are driven by the goals of stabilizing the payments system and the financial system. Other major norms, such as market efficiency, are important in terms of their influence, but they can become counterproductive to the Fed’s ability to stabilize the payments system and the financial system at times, as they were during the mid-to-late 1990s. Given the SFM, normative systems analysis, and description of time and timeliness in the Fed’s operations, seven general principles of the Fed’s operations are presented, several of which are contrary to popular opinion (even among economists) regarding how central bank operations actually work. Of overarching importance is the realization that the Fed’s operations are concerned with setting an interest rate, not controlling the money supply, which is in fact not possible. The events of August 2007 through December 2008 relevant to the Fed’s daily operations are described and considered within the context of the previously laid out general principles, while as a result of information gathered during this period, three additional general principles of the Fed’s operations are provided.

What If the Government Just Prints Money

A number of debates are taking place regarding the appropriate response of monetary policy both to the crisis and the Great Recession that followed, particularly in regard to interest on reserve balances and so-called unconventional monetary policy operations. This paper describes in detail an endogenous money perspective on the interactions between central bank operations and banks, and then shows that interest on reserve balances does not impede the transmission of monetary policy, while quantitative easing does not necessarily enhance it.