Controlling Inflation

There are two broad ways to control inflation and buffer stocks are involved in each:

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

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

Full employment requires that there are enough jobs created in the economy to absorb the available labour supply. Focusing on some politically acceptable (though perhaps high) unemployment rate is incompatible with sustained full employment.

Under the neo-liberal policy regime, central banks have, increasingly, been given the responsibility by government for managing the price level. In conducting monetary policy to fulfill their major economic objectives, central banks manipulate the interest rate and attempt to manage the state of inflation expectations.

These policy tools are employed to achieve an “optimal” level of price stability and capacity utilisation (typically assumed to be invariant in the long-run to nominal aggregates). Where negative real effects from the operation of inflation-first monetary policy are acknowledged they are theorised to be necessary for optimal long term growth and employment and small in magnitude.

These considerations suggest that the central bank, as part of the consolidated currency-issuing government sector, has another, somewhat similar yet far more effective buffer stock option which is in fact an alternative way of managing the unemployment program.

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

The employment buffer stock approach (the JG) exploits the imperfect competition introduced by fiat (flexible exchange rate) currency which provides the issuing government with pricing power and frees it of nominal financial constraints.

The JG approach represents a break in paradigm from both traditional Keynesian policies and the NAIRU-buffer stock approach. The difference is a shift from what can be categorised as spending on a quantity rule to spending on a price rule.

For example, under current policy, the government generally budgets a quantity of dollars to be spent at prevailing market prices. In contrast, with the JG option, the government additionally offers a fixed wage to anyone willing and able to work, and thereby lets market forces determine the total quantity of government spending. This is what I call spending based on a price rule.

Under the JG scheme, the government continuously absorbs workers displaced from private sector employment. The JG workers thus constitute a buffer employment stock and would be paid the minimum wage.

Many economists who are sympathetic to the goals of full employment are sceptical of the JG approach because they fear it will make inflation impossible to control. To answer these claims, I once again outline the inflation control mechanisms inherent in the JG model. If the private sector is inflating, a tightening of fiscal and/or monetary policy shifts workers into the fixed-wage JG-sector to achieve inflation stability without unemployment.

Unemployment buffer stocks and price stability

There have been two striking developments in economics over the last thirty years. First, a major theoretical revolution has occurred in macroeconomics (from Keynesianism to Monetarism and beyond) since the mid 1970s. Second, unemployment rates have persisted at the highest levels known in the Post World War II period and in the current crisis have sky-rocketed upwards.

The concept of full employment as a genuine policy goal was abandoned with introduction of the natural rate of unemployment hypothesis (Friedman and Phelps) which has became a central plank of current mainstream thinking.

It asserts that there is only one unemployment rate consistent with stable inflation. In the natural rate hypothesis, there is no discretionary role for aggregate demand management and only microeconomic changes can reduce the natural rate of unemployment. Accordingly, the policy debate became increasingly concentrated on deregulation, privatisation, and reductions in the provisions of the Welfare State with tight monetary and fiscal regimes instituted.

The almost exclusive central bank focus on maintaining price stability on the back of an overwhelming faith in the NAIRU ideology has marked the final stages in the evolution of an abandonment of earlier full employment policies.

The modern policy framework is in contradistinction to the practice of governments in the Post World War II period to 1975 which sought to maintain levels of demand using a range of fiscal and monetary measures that were sufficient to ensure that full employment was achieved. Unemployment rates were usually below 2 per cent throughout this period.

Under inflation targeting (or inflation-first) monetary regimes, central banks shifted their policy emphasis. They now conduct monetary policy to meet an inflation target and, arguably, have abandoned any obligations they have to support a policy environment which achieves and maintains full employment. Unemployment since the mid-1970s has mostly persisted at high levels although in some economies low quality, casualised work has emerged in the face of persistently deficient demand for labour hours.

However, central bankers do not characterise their approach in this way and they avoid recognition of the empirical fact that contractionary monetary policy continues to generate output and employment losses which are permanent. Instead the dominant paradigm suggests that full employment is a natural derivative of the maintenance of price stability even though this approach to price stability requires the maintenance of an unemployed buffer stock.

The use of unemployment as a tool to suppress price pressures has, based on the OECD experience in the 1990s, been successful in that inflation is now no longer driven by its own expectations. One explanation is that unemployment temporarily balances the conflicting demands of labour and capital by disciplining the aspirations of labour so that they are compatible with the profitability requirements of capital.

Similarly, low product market demand, the analogue of high unemployment, suppresses the ability of firms to pass on prices to protect real margins. Other explanations for the effectiveness of unemployment in controlling inflation are possible.

The empirical evidence is clear that most OECD economies have not provided enough jobs since the mid-1970s and the conduct of monetary policy has contributed to the malaise. Central banks around the world have forced the unemployed to engage in an involuntary fight against inflation and the fiscal authorities in many cases have further worsened the situation with complementary austerity.

How useful is the NAIRU as a guide to policy? There is a growing literature that shows that the NAIRU is useless as a guide to policy.

Please read my blog – NAIRU is a myth! – for more discussion on this point.

While there may be some stability between inflation and unemployment for a period, experience from many OECD countries suggests that a sudden shock, especially from the supply side (as in 1974) can worsen the unemployment resulting from a deflationary strategy, which is attempting to exploit a given Phillips curve.

Evidence from the OECD experience since 1975 suggests that deflationary policies are effective in bringing inflation down but impose huge costs on the economy and certain demographic groups, which are rarely computed or addressed.

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

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

Further, despite its centrality to policy, the NAIRU evades accurate estimation and the case for its uniqueness and cyclical invariance is weak. Given these vagaries, its use as a policy tool is highly contentious.

Employment buffer stocks and price stability

It is clear that central bankers are now using buffer stocks of unemployed to achieve a desirable price level outcome. While the real effects of such a policy have been contested, there is overwhelming evidence to suggest that the cumulative costs of this strategy in real terms have been substantial.

Several researchers have found that sacrifice ratios remain significant and persistent, meaning that GDP losses during disinflation episodes are substantial. Additionally, a major component of this monetary policy stance is the persistent pool of unemployed (and other forms of labour underutilisation, for example, underemployment) as a buffer stock for wage and thereby price stability.

In addition to lost output, other real costs are suffered by the nation, including the depreciation of human capital, family breakdowns, increasing crime, and increasing medical costs.

So the unemployment pool is thus widely recognised and monitored as a price anchor, a primary concern for price stability in general, and a prime object of monetary policy. However, the effectiveness of an unemployed buffer stock has been shown to deteriorate over time, with ever larger numbers of fresh unemployed or underemployed required to function as a price anchor that stabilises wages.

So in recognising that the effectiveness of unemployment per se as a price anchor is a further function of the terms, conditions, and administration of the unemployment program, MMT recommends management of the unemployment policy and programs be made a function of the agency responsible for said price stability – the central bank.

The question that arises is whether using a persistent pool of unemployed (or casualised underemployed) is the most cost effective way to achieve price stability?

An understanding of MMT principles suggest that a better alternative would be to utilise an employed buffer stock approach which is in fact an alternative way of managing the unemployment program.

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

Bill Mitchell


16 responses to “Controlling Inflation

  1. I am in the Ed Harrison camp on the ELR. The ELR makes perfect sense in the MMT paradigm. But the practical implementation is just icky. I doubt it could be passed either here in the US or in Oz within the next 20 years barring a horrible second down leg in the depression. I worry about the choice of projects, and the decision criteria of ‘willing and able’ to work. I worry about ‘creep’ of government mandates.

    Not that what we have now is great. Basically, your list of flaws in using unemployment as a buffer is a list of ways we are real world poorer. And not just in pure GDP measurable ways- the mental impact of unemployment is truly vast and impacts entire communities.

    What are the odds of the ELR getting passed in Oz at any point soon?

  2. Clonal Antibody

    When looking at the JG/ELR policy, valuable lessons can be learned from the WPA experience. I posted some of the links in the discussion on Nick Rowe’s post on Functional finance and LRGBC

  3. Clonal Antibody

    To really get JG/ELR, you have to delve a bit into the history of the New Deal’s WPA. It is icky only for those who either have ideological blinders, or have not looked at all at the history of the New Deal. In particular, there has been much misrepresentation and selective bias in looking at the WPA and its impact.

  4. TC, the odds of a JG passing in Australia soon are NIL. Interestingly though Australia had a WPA style program in the same period and it was actually called Full Employment. Our National Archives has a copy of its White Paper (photographs), I’m endeavouring to put it into a Google Doc to make it more freely accessible. What I have done of it so far also fits the MMT paradigm. I am also personally familiar with the flaws of using unemployment as a buffer stock.
    As I think I said once at your place, I recognise the political constraints of putting a JG in place but it fits in the MMT paradigm as a prescription given we know the operational realities of our currencies. From just an economics perspective though I do recognise the possibility of malinvestment but I rate the probability low especially when I look at the introduction of things like the Brixton Pound in the UK.


    That really is a spam catching name but you should be right for any time you wish to comment here now. As I said above, attempting to put Australia’s Curtin/Chifley government of White Paper on Full Employment (our WPA) into a Google Doc to make it more accessible.

    Kind Regards to you both.

  5. Part of the reason I proposed the TC rule about government spending was because I think the ELR is political plutonium. If we cannot have the ELR, then at least we can have something that acts like an ELR.


    The New Deal programs were not bad, and I also think the U.S. defense budget “rhymes” with the ELR. But that is not what I am really talking about when I say the implementation is icky. I worry about government creep, and having the government employ what would certainly be at least 10 million U.S. Citizens requires a bureaucracy on such a vast scale that I can barely put my mind around it. Then choosing where to direct this literal army of people is another huge series of contriversial decisions.

    It isn’t that I don’t like the ELR. I just think that getting to the ELR is the task of a generation. We are not there yet.

    And that is why I put the TC rule out into the world. It is a rule that could be implemented next year – and then modified as the unemployment rate gets lower, and lower, and lower, until it becomes an effective ELR.

  6. Clonal Antibody

    It will be well worth your while to read the rather long article (56 pages) by Amenta – Bring Back the WPA: Work, Relief, and the Origins of American Social Policy in Welfare Reform* and also the book by John David Millett “The Works Progress Administration in New York City” 1978 – this is the second edition, the first one being published about 40 years earlier.

    From Indiana University’s WPA exhibit

    By March, 1936, the WPA rolls had reached a total of more than 3,400,000 persons; after initial cuts in June 1939, it averaged 2,300,000 monthly; and by June 30, 1943, when it was officially terminated, the WPA had employed more than 8,500,000 different persons on 1,410,000 individual projects, and had spent about $11 billion. During its 8-year history, the WPA built 651,087 miles of highways, roads, and streets; and constructed, repaired, or improved 124,031 bridges, 125,110 public buildings, 8,192 parks, and 853 airport landing fields.


    Particularly novel were the special programs. The Federal Writers’ Project (more information available from Indiana State University’s library) prepared state and regional guide books, organized archives, indexed newspapers, and conducted useful sociological and historical investigations. The Federal Arts Project gave unemployed artists the opportunity to decorate hundreds of post offices, schools, and other public buildings with murals, canvases, and sculptures; musicians organized symphony orchestras and community singing. The Federal Theatre Project experimented with untried modes, and scores of stock companies toured the country with repertories of old and new plays, thus bringing drama to communities where it had been known only through the radio.


    Headed by Harry L. Hopkins and supplied with an initial congressional appropriation of $4,880,000,000, it offered work to the unemployed on an unprecedented scale by spending money on a wide variety of programs, including highways and building construction, slum clearance, reforestation, and rural rehabilitation. So gigantic an undertaking was inevitably attended by confusion, waste, and political favoritism, yet the ‘pump-priming’ effect stimulated private business during the depression years and inaugurated reforms that states had been unable to subsidize.

    • Great stuff Clonal.

      Note that I am not a huge anit-waste guy. I know there will be lots of waste and graft.

      I consider it very unlikely we’re going to have a WPA like program at any point soon. I wrote over at my place about the ELR effects of military spending. I do not see how we can convince people to implement it barring a massive depression.

      MMT isn’t some perfect program that should only be implemented if the programs are exactly what we would prefer. It makes sense to have many nuanced ideas, programs, and proposals. Incremental change is the norm, while gigantic changes are rare. We should be prepared to take small victories and run with them.

  7. Clonal Antibody

    There is a discussion at Brad DeLong’s web site that clearly shows that Lebergott clearly understates the impact of the WPA on unemployment, by counting the people working with the WPA as still unemployed. This unemployment series has then been used by the detractors of the WPA to say that the WPA had no impact on unemployment.

    Eric Rauchway had an interesting take on the above

    This is a lesson in reading the notes.

    Begin with

    Carter, Susan B. , “Labor force, employment, and unemployment: 1890–1990.” Table Ba470-477 in Historical Statistics of the United States, Earliest Times to the Present: Millennial Edition, edited by Susan B. Carter, Scott Sigmund Gartner, Michael R. Haines, Alan L. Olmstead, Richard Sutch, and Gavin Wright. New York: Cambridge University Press, 2006.

    Read the footnotes! Then have a look at

    Weir, David R. “A Century of U.S. Unemployment, 1890-1990: Revised Estimates and Evidence for Stabilization.” Research in Economic History 14 (1992): 301-346.

    And, well, you could stop right there, but that would be missing the fun. But inasmuch as neither of these sources is easy to get hold of, let me explain why this is such a fun topic.

  8. Hi Senexx and all,

    I’ve read the piece with interest. And I hope next post goes into explaining how MMT ‘s employment buffer stock approach tackles the problem of inflation control.

    However, there’s a point that I always find unconvincing, not so much in the justification of MMT, but on the explanation MMTers give to the current economic practices: there’s always the impression that mainstream economists are either too stupid or too negligent to realize they are hurting people.

    Frankly, this explanation does not convince me. These people are maintaining a pool of under/unemployed, and I doubt they are unaware of that.

    So, my question is, in your opinion, who benefits from this?

  9. Magpie, a buffer stock of unemployed lowers worker bargaining power by increasing competition for jobs. With the push on to reduce or remove the minimum wage, this bargaining power would be reduced further in a race to the bottom with the developing world. Obviously, capital likes this arrangement, and mainstream economists are in the employ of capital not labor, either directly or indirectly.

    The ELR would provide a buffer of employed instead, which capital could draw on. The buffer is maintained, but it is employed, so workers have some control over bargaining. This is the very important difference of negotiation between free persons or between master and slave, unemployed workers are not free to negotiate. As a result the present minimum wage is below subsistence and low wage workers typically work several jobs.

    The ELR would also a establish a floor wage/benefit that would act as a nominal price anchor that defines price stability. The definition of inflation is a general and continuous rise in prices, including wages. The chief contributor to core inflation is wage increases.

    There’s a decent summary over at

  10. Thanks Tom,

    I totally agree with your analysis.

    Finally someone else –other than the crazy Magpie, that is– calls the unmentioned elephant in the room, elephant.

    Just let me take advantage of the opening you provided here and ask the next logical question (probably more for the benefit of the other readers than to your own, as I suspect you know the answer already):

    You said:

    “The definition of inflation is a general and continuous rise in prices, including wages. The chief contributor to core inflation is wage increases.”

    In a society where nobody does anything against rising executives’ compensations (including high ranking bureaucrats), rising capitalists’ profits, etc. etc. what’s the consequence of having wages (the main income source of workers) systematically kept lower?

  11. The preferred outcome for the capitalist class is asset appreciation, since they are the ownership class, with low wages, hence, low core inflation. This keeps interest rates low, which favors investment. The result is that gains from productivity flow to the top, since they are not distributed, worker bargaining power being low.

    Now, with offshoring, the actual buffer stock of labor is global, so workers in the developed world are competing with workers in the developing world, and workers in the developed world are looking over their shoulders at workers in the undeveloped world that are waiting in the wings.

    This is the present agenda and has been for several decades. It is the basis of neoliberal economic policy, initially put into effect by Thatcher and Reagan.

    The way around this is through progressive taxation and taxing away economic rent —land rent, monopoly rent, and economic rent. Progressive taxation of income discourages extreme inequality of incomes.

    Economic rent is defined broadly as gain that does not accrue from productive contribution. Taxing economic rent discourages non-productive activity (rent-seeking) and encourages productive activity (primary investment and the income resulting from it).

    Add the ELR and everyone that wants employment has a job offer,

    The result is distributed prosperity, full employment, and price stability in an environment that encourages productive investment and innovation.

  12. Not bad, not bad at all.

    You are aiming at inequality and you are spot on there.

    To put that in pictures, referring to the American case (sorry, I don’t believe we have any resources like this in Oz):

    20 Facts About U.S. Inequality that Everyone Should Know

    I particularly liked the “workers in the developed world are competing with workers in the developing world”. (And for any white collar workers/small businesspeople hoping this refers only to blue collar workers in manufacturing, wake up. This will touch you sooner, rather than later.)

    I don’t quite agree with your recommendation (JG/ELR), though, as I suspect it to be a partial solution at best. However, as I don’t much know about JG/ELR, I reserve my judgement on that until a formal exposition.

    Although I suspect, for brevity, you did not intend your exposition to be seen as exhaustive, I will add a couple of things:

    (1) Capitals have been all but relieved of the burden of competition: now it is nations that compete to attract capital (and states and provinces, within a nation), just like local workers need to compete with foreign workers. Nations compete among themselves by lowering taxes, subsidizing capitals, removing environmental and health controls, facilitating (!) capital flows, removing industrial relations legislation, emasculating the organized labour movement. In other words: by externalizing capitalists’ costs/reducing transaction costs.

    (2) The political system is losing any semblance of legitimacy. I suggest you read Mother Jones’ article “Plutocracy now”. [1]

    (3) Well, let me add a third thing: a society can no longer afford to purchase its social output. Daron Acemoglu [2] made the case for the housing bubble and speculative finance as a temporary (and ultimately counterproductive) way around. And one doesn’t need to go to Marx to see where this takes us to. Since Adam Smith and Malthus, this was the nightmare of classical political economists, because it means the system is unstable.

    [1] Plutocracy Now: What Wisconsin Is Really About

    Or have a look at the chart under the label “Capitol gain” here:

    [2] Acemoglu on Inequality and the Financial Crisis

  13. Magpie, the ELR has been worked on most among the MMT’ers by Bill Mitchell.

    Here are some references.

    • Thanks Tom,

      I do know Prof. Mitchell proposes it. And I respect his work and I believe he means well.

      What I am not sure is whether, as an economist, he has considered the extra economic implications of the situation.

      Mind you, I don’t know what to do. So, you might as well take your pick. At least he has a concrete proposal.

  14. TC: MMT isn’t some perfect program that should only be implemented if the programs are exactly what we would prefer. It makes sense to have many nuanced ideas, programs, and proposals. Incremental change is the norm, while gigantic changes are rare. We should be prepared to take small victories and run with them.

    This is an advantage of MMT. By understanding how the existing system works MMT can recommend policy tweaks to make it work better without needing to overhaul or replace the entire economic or monetary system, as some other proposals would require, like the Kucinich bill or Austrian proposals. While MMT has a comprehensive macro policy plan, although it has not yet been articulated under one cover to my knowledge, this does not need to be implemented all at once. Even relatively minor tweaks can make a huge difference by reversing disastrous courses,. For example, knowledge of sectoral balances and functional finance shows “expansionary fiscal contraction” — what they are calling austerity now — to be a numbskull notion.

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