The Limits of Pump Priming

Michael Stephens | October 25, 2011

Here’s one fairly standard reading of our economic policy challenge:  the economy needs more pump priming, the federal government has more than enough fiscal space to provide it, but for political reasons it won’t be forthcoming.  (If you needed further evidence of that last proposition, take a look at the latest House Republican job creation offering:  repealing a law designed to prevent tax evasion by federal contractors, paid for by kicking some seniors off of Medicaid.  Take a moment to gape at the boundary-probing cynicism.  This is the legislative equivalent of planting a giant foam middle finger on the White House lawn.)  So as far as aggregate demand goes, in other words, there’s little reason to think that the federal government will step into the breach (and as things stand, we expect the government to be withdrawing demand from this economy).  But a new one-pager by Pavlina Tcherneva (“Beyond Pump Priming“) suggests that the above reading of the situation is … too optimistic.

Even if the AJA, or some other form of aggregate demand injection is passed, there are serious limitations to relying too heavily on an approach that boils down to boosting growth and hoping for the right employment side effects.  Featuring a rather stark graph portraying the ratcheting up of long-term unemployment over the last several decades, the piece argues that there are shortcomings to relying too exclusively on pump priming (which is largely what the AJA is, aside from a small amount of infrastructure).

The alternative is to take dead aim at the employment outcomes we need—to directly target the unemployed.  Tcherneva explains why, instead of just trying to fill the demand gap for output, we ought to focus on closing the demand gap for labor, through public works and job guarantee programs that directly employ the unemployed.  Among the benefits of the latter approach are an ability to focus on particularly distressed regions of the country.

Read the one-pager here.


4 Responses to “The Limits of Pump Priming”

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  1. Comment by Hugo HedenOctober 25, 2011 at 2:16 pm   Reply

    With respect to the suggested Job Guarantee program (or “ELR”) versus pump priming, we’ve currently drafting something like the following on the MMT Wiki:

    An important question concerns the impact this program would have on aggregate demand. Is full employment going to increase aggregate demand sufficiently to cause accelerating demand-pull inflation[5]?

    JG is fundamentally different from the blunt job creation tool of traditional Keynesian general demand stimulus (sometimes called “pump priming”). There, labor from all levels of the productivity spectrum is hired (sometimes the most technically proficient ones), taking away these workers from private sector activity. The government competes for these workers in the market with the result of bidding up wages, a process that can drag up the entire wage structure. The hope is that some of the added demand will “trickle down” (via spending multipliers) to ultimately create new jobs for unemployed.

    It is true that as long as there is considerable slack in the economy, firms tend to meet increasing demand by increasing output rather than prices, for various reasons[7]. This results in decreased unemployment without much inflation.

    But to induce firms to hire the least skilled or otherwise least desirable workers would require very high levels of aggregate demand[1]:134. As aggregate demand increases, some sectors will reach bottlenecks before others, so that they can not increase output further. From that point they will instead meet increasing demand by raising prices. Inflationary pressure therefore arises long before full employment has been reached. In summary, general aggregate demand stimulus can not achieve full employment with acceptable levels of inflation.

    This is not to say that aggregate demand stimulus is never appropriate. For the many grossly over-taxed economies of today it certainly is. But that is a different policy option, independent of the issue of Job Guarantee.

    With JG in place (after initial prices disturbances have stabilized), aggregate demand is kept at just the right level. There is no indirect general demand stimulus to “trickle down” via spending multipliers. The economy is instead stimulated at the “bottom” by employing the unemployed directly. They are hired at a constant price so that market wages are not chased further and further upwards.

    This is all a result of automatic policy. At the point of full employment, JG raises aggregate demand no further. If private demand were to rise, JG employment – and government deficit spending – automatically falls.

  2. Comment by Hugo Heden — October 25, 2011 at 3:31 pm   Reply

    Excellent, thanks, will take a look.

  3. Comment by Clonal Antibody — October 25, 2011 at 3:51 pm   Reply

    I like the one pager. However, it has much economic jargon to be used to mobilize political support.

    Is there anyway, it could be put in as a set of political demands, that could be used by, say, the #OWS – a sort of rallying cry?

    We could always refer back to the one pager, and the papers on which it is based.

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