The full employment question

"Never mind the public finances. Look after the economy and the deficit will look after itself." For years, critics of George Osborne such as me echoed Keynes' old line. At last, the Tories are, by their own lights, heeding this call. And financial markets hate it. Does this mean the Keynesian advice was wrong all along?

No. There's a big difference between the 2010s and now.

This difference is not that Kwarteng is mistaken to think that tax cuts will stimulate long-term productivity growth. He probably is, but this isn't the main problem. Even if he had announced the best supply-side policies imaginable, these would not have a significant impact on the economy in the next few months simply because it takes time for capital and labour to learn of new and better opportunities and move to them. As Banerjee and Duflo showed in Good Economics for Hard Times, economies are sticky and slow to adjust to change.

Instead, we are closer to full employment now than we were ten years ago. And full employment changes how macro policy should be conducted. When there is unemployment any fiscal policy that boosts aggregate demand will lead to the greater utilization of unemployed assets (capital and labour) and hence to increased real output. At full employment, however, this cannot happen and so we get inflation instead. Tax cuts might have boosted growth ten years ago when there were idle resources, but now we are nearer to full employment they are more likely to lead to higher inflation.

Which is what financial markets expect. Their fear of higher inflation has driven five-year gilt yields up to 4.4%, compared to only 1.4% as recently as May*.

This raises three issues.

One is: how much will this fiscal stimulus add to demand? In this context, the fact that the tax cuts are skewed to the rich is a good thing: the rich have a high propensity to save and so won't boost aggregate demand and inflation much. But even so, the impact is positive - as of course is the impact of capping energy prices**.

A second issue is: how close are we actually to full employment? The official jobless level is just over 1.2m. That's less than the number of vacancies, and its lowest since 1975. On top of this, though, there are 1.7m people out of the labour force who would like a job. Adding these to the officially unemployed gives us a level of 2.9m, which is the lowest since data began in 1992. Official figures show that there are also 2.8m people who are working fewer hours than they'd like - although this is the lowest number since before the financial crisis.

Whether such numbers mean we are actually at full employment is moot: there's always some frictional unemployment and under-employment simply because of mismatches between supply and demand***. What we can say, though, is that we are much closer to full employment than we were ten years ago. Back then there were one million more under-employed and two million more unemployed and inactive wanting a job. Which means it is plausible that a given boost to demand now will lead to a worse output-inflation mix than it would have done in 2012.

Thirdly, even if we are at full employment, is this inflationary? In the past companies have responded to high demand by figuring out (pdf) ways to raise productivity. That's one reason why full (male!) employment in the 50s was not inflationary. But markets can be forgiven for doubting whether a repeat is possible. For one thing, forty years of mass unemployment has made bosses lazy: in relying upon abundant labour they've lost the habit of thinking how to raise productivity. For another, high policy uncertainty deters companies from investing in the capital equipment that might raise productivity. And for yet another, high demand now is less likely to lead to a big influx of migrant labour, in part because sterling wages no longer buy so much in foreign currency.

It's likely, therefore, that a fiscal stimulus today will be more inflationary and less good for output than it would have been ten years ago. Hence the market reaction.

It's in this context that Sunak's health and social care levy made sense. if we want more health and social care the question is not: where will the money come from? It can be borrowed. Instead, it is: where will the real resources come from - the carers, nurses and premises for care homes?

When there is mass unemployment, the answer's simple: they come from the dole queue and vacant property. At full employment, however, the answer is different: they must come by shifting people from one employment to another. The logic for higher national insurance contributions was that it would do this: it would depress consumer spending and hence facilitate a shift in labour from retail and hospitality to the care sector.

Granted, the implementation of the policy should have been better, for example in helping people more to retrain as health and care workers. But the macroeconomic logic was sound, assuming we were near full employment. Today's Tories are rejecting this logic. That wouldn't be a problem if there was significant unemployment. But there might not be, and indeed Kwarteng's attempts to cajole UC claimants into working more suggests that he believes there is not.

Now, you might question the facts here. Maybe we are still some way from full employment, or maybe our nearness to it won't be as inflationary as feared.

For my purposes, however, this is not the point. The point is that the policy that's right for unemployment is not the same as that which is right for full employment. Macroeconomic economic policy should be a merely empirical matter, not a matter of ideology or sloganeering. In this respect, however, the Tories have been consistent: they were wrong in the 2010s, and might well be wrong in the 2020s. But that's the thing about them: they are so much more ideological than we Marxists.

* Granted, all the rise is due to a rise in real yields: Bank data shows that inflation expectations have actually come down since then. But that is because markets expect rate rises to curb inflation: higher mortgage rates will crater discretionary consumer spending.

** Yes, the price cap cuts inflation as a mathematical fact. But it raises it as a behavioural one: because we'll have more money to spend than we otherwise would, demand will be higher which is potentially inflationary.

*** From a macroeconomic point of view, "full employment" is defined as the unemployment rate at which inflation takes off. This need not be the same as full employment from a human point of view.

Comments

[Blissex]

«"Never mind the public finances. Look after the economy and the deficit will look after itself."»

IIRC that was about wages, rather than "the economy", which in contemporary terms means "investors". The rationale is that most taxes come from wages.

«And for yet another, high demand now is less likely to lead to a big influx of migrant labour»

Looking at the recent past, in 2021 (absolute) immigration was the highest for several decades, at around 1m immigrants in one year, mostly from poor Africa and Asia countries (but also 200,000-300,000 relatively affluent immigrants came from Hong-Kong many to become landlords). The tonic effect on house prices and rents has been marvellous.

While most immigrants were poor, many were skilled, so around 60% of new medical doctors were immigrants, also because the government does not want to fund expensive medicine degrees, prefers for UK doctors to be trained at the expense of foreign taxpayers.

[Blissex]

«It's likely, therefore, that a fiscal stimulus today will be more inflationary»

I find it very strange that so many authors have been commenting on fiscal policy when monetary/credit policy is even more exceptionally expansionary than usual: with RPI at 12% (for now), the BoE rate is just 2.25%, and typical mortgage rate are at 4-5%, that is real interest rates are deeply negative, signaling the markets that the BoE is more determined than ever to push up asset prices, in particular property (Truss/Kwarteng have cut in half again stamp duty).

Even the fall in the pound is easier to attribute to deeply negative real interest rates than to higher deficits. Anybody who can is dumping the pound, also because how inflation is cutting the real value of debt by 12% per year (so far); cash-is-trash, and anybody who can is borrowing as much as they can grasp to buy assets, like property, that are expected to increase in valuation faster than inflation.

[Blissex]

For those more interested in understanding why a government of extremist libertarians is instead heavily intervening in the markets with massive price subsidies, huge tax cuts, and extremely expansive credit policy:

https://www.craigmurray.org.uk/archives/2022/09/caught-in-a-cycle-of-despair-and-exploitation/
“Truss’s conversion to action on energy prices is not motivated by a sudden concern for poverty or the needs of ordinary people. I learnt of it on Sunday night, before her U turn was briefed, from senior Foreign Office (FCDO) sources. Government polling has indicated a substantial fall in public support for NATO’s proxy war in Ukraine, due to unsustainable energy prices at home.”

Trebles all round (for tory voters), the "home front morale" must be kept high.

[Scurra]

There's also the question of how more 'permanent' jobs are affecting the market.
We can talk lots about retail/hospitality/care workers/customer service or whatever, where things like zero-hour-contracts may be the norm and the Chancellor likes to ask why folk working 15-hours a week don't do more (without listening to the actual answer, mind.)
But what about the full-time professional jobs? If we are close to full employment there then how is the job market handling that? (For reference, this is both a rhetorical question and also, I don't know. But I think that the renewed focus on immigration is clearly a part of it.)

[Blissex]

"Never mind the public finances. Look after the economy and the deficit will look after itself."

https://www.oxfordreference.com/view/10.1093/acref/9780191866692.001.0001/q-oro-ed6-00006275

"Look after the unemployment and the Budget will look after itself.
radio broadcast, 4 January 1933, in Listener 11 January 1933"

Ah the original quotation was about "unemployment", as the given link to "rortybomb" quotes.

The same logic appears in "The General Theory": that as long as the wages are doing well, taxes will be plentiful and welfare costs will be small.

[Nanikore]

"There's a big difference between the 2010s and now."

A very major difference is that the the US is not flooding global markets with dollar liquidity. Those days are over. Countries who have external deficits and are dependent on international capital markets for funding are the most exposed to this returned reality.

(The exception is the US which is the world's reserve and safe haven currency. Yes Sterling is an official reserve currency (one of six) but it is not in quite the same league.)

There has been a lot of American eccentric theories thrown around (Market Monetarism, New Keynesianism and its ZIRB) that have ignored the balance of payments constraint. The linkage between the trade deficit and government deficit is subtle and nuanced, but in the UK's case is as we have just seen, obviously there.

"The message of financial markets is that there's a limit to unfunded spending and unfunded tax cuts"(Mark Carney, today).

In other words, the UK economy is not completely unlike a household. That will be news for some. And also news for some: the UK is exposed even though it issues debt in its own currency. The emergency measures the BOE has been forced into to prop up the bond market are actually inflationary when we have an inflation problem and pressures on Sterling.

[Nanikore]

@Blissex

Government polling has indicated a substantial fall in public support for NATO’s proxy war in Ukraine, due to unsustainable energy prices at home.”

I think people also are not entirely convinced by the warmongering. There seems to be very little effort made into trying to find a peaceful solution and people would suspect that this government would be cynical enough to use the war in Ukraine to suit their own ends.

[Nanikore]

I said "American eccentric" above, should read "American-centric".

[Nanikore]

Unfortunately there is a paywall on this, but I am sure it would be very funny:

https://www.telegraph.co.uk/news/2022/09/29/liz-truss-has-offered-sound-economics-terrible-communication/

[Blissex]

«liz-truss-has-offered-sound-economics-terrible-communication/»

But that is indeed quite correct, high inflation with much lower interest rates is "sound economics" indeed:

* Pursued for a couple of year it reduces the real burden of wages by 20-30%, making them much more competitive, especially if the exchange rates falls too, at the same time that it greatly increases margins too.

* It reduces the real burden of mortgages by the same 20-30%, and with real interest rates of nearly -8%, it means that it is possible to buy on deeply negative real rates property where prices and rents are rising by 3% in real terms, and the falling pound is going to stimulate purchases of english property from those with ample availability of funds abroad.

No surprise that the "Telegraph" calls that "sound economics", for their "our own", tory voters, it is pretty good.

«but I am sure it would be very funny»

The "Telegraph" and their readers have just a notion of "our own" that is is likely different from yours.

I cannot see anything funny or illegitimate about that: for most of the people in the UK that are not part of the notion of "our own" of the typical reader of the "Telegraph", around 99% of people, those outside these islands, are not "our own"; their instinctive notion of "our own" is just a differently defined group from that of readers of the "Telegraph".

As it clear when they claim that free health care, low cost social housing, well paying jobs, generous social insurance and good public services are a human right (but only for that "our own" that excludes 99% of humanity).

[Blissex]

«liz-truss-has-offered-sound-economics-terrible-communication/»

As to the "terrible communication":

* The right-wing globalist "whigs", who want to take back control of the Conservative Party (having already taken over the New, New Labour Party), have eliminated nationalist "kipper" Johnson thanks to control of most media speaking to Conservative voters.

* They are now running a similar campaign using the same media against nationalist "kipper" Truss, which would not have happened if nationalist "kipper" Conservative association member had chosen globalist "whig" Sunak as leader.

I guess that the globalist "whig" factions of "The Establishment" is even prepared to throw the elections to New, New Labour to take back the Conservative Party, just as the globalist "whig" faction of Labour tried worked to throw the 2019 election to the Conservatives take back the Labour Party.

[ltr]

Government polling has indicated a substantial fall in public support for NATO’s proxy war in Ukraine...

[ Is there any meaningful public advocacy for negotiation? Would there be any Labour MP who would advocate negotiation? ]

[ltr]

https://www.nytimes.com/2022/09/30/business/uk-mortgage-markets.html

September 30, 2022

‘You Can Feel the Fear’: U.K. Borrowers Face Up to a Broken Mortgage Market
The financial turmoil in Britain has led to soaring interest rates, prompting many lenders to withdraw products and stoking worry among homeowners about rising costs.
By Isabella Kwai

https://www.nytimes.com/2022/09/30/business/bonds-pensions-bank-of-england.html

September 30, 2022

Sleepy Corner of U.K.’s Pension Industry Forced the Bank of England’s Hand
Complex financial instruments that pension funds use to minimize the impact of interest rate changes led to the bond market rout.
By Joe Rennison