Macroeconomic stabilization through an employer of last resort

Journal of Economic Issues, March, 2007 by Scott T. Fullwiler

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 (see Forstater 1998; Mitchell 1998; Wray 1998; 2000; Mitchell and Wray 2004; Tcherneva and Wray 2005; and numerous publications available at the Center for Full Employment and Price Stability and the Centre of Full Employment and Equity). 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 on the state of the economy. Supporters have played an important advisory role in Argentina's Jefes de Hogar (hereafter, Jefes) 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 ELK 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 result 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, ELK proponents argue that societies would do better to consider whether they can "afford" involuntary unemployment. (1) The proposed ELK'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, 5) notes, "[h]ow 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 quantitatively model 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.

The Fairmodel and Macroeconometric Simulation

The Fairmodel is a well-known, large macro-econometric model of the U.S. economy developed in the 1970s by Ray Fair. The model is dynamic, nonlinear, and simultaneous and it incorporates household, firm, financial, federal government, state and local government, and foreign sectors of the economy. The model combines 30 stochastic equations that are estimated using the two stage [east squares method with another 100 identity equations. National Income and Product Account (NIPA) and Flow of Funds data are completely integrated into the model within the identity equations; balance sheet and flow of funds constraints are thus fully accounted for. There are 130 endogenous variables and over 100 exogenous variables.