What Does Full Employment Mean? And Why At ‘Full Employment’ Are So Many People Still Looking For Work? The Modern Monetary Theory (MMT) Perspective
Orthodox Economics Versus Modern Monetary Theory (MMT): Perspectives on the Meaning of the Phrase ‘Full Employment’
What does full employment mean? Why would I bother asking such a daft question? Surely it’s not possible to write an entire article on defining the phrase ‘full employment’? It’s obvious: when everyone who wants a job has one – that’s full employment. Take your fingers off that keyboard, Jim; your job’s done.
Well, no. Sadly for us, the phrase ‘full employment’ is the Mr Slippery of economics. Every school of economic thought has its own definition – and most of them don’t come close to that simple description. The main reason is that full employment is always viewed as an unfriendly bed-fellow to inflation.
So, with that in mind, before we can define full employment, we need to understand two other concepts: The ‘Philips Curve’ and the ‘Non-Accelerating Inflation Rate of Unemployment’, the ( NAIRU).
What Is the Phillips Curve?
The Phillips Curve is an economic theory suggesting that there is a relationship between the level of employment and the level of inflation. Specifically, it posits that, as the economy approaches full employment, the rate of inflation accelerates. The name, ‘The Phillips Curve’, comes from a study carried out by A.W. Phillip in 1958 showing wage and unemployment changes in the period between 1861 and 1957.
What Is the Non-Accelerating Inflation Rate of Unemployment?
The Non-Accelerating Inflation Rate of Unemployment (NAIRU) refers to a rate of unemployment that neither accelerates nor decelerates inflation. It does not mean a rate at which there is no inflation or no deflation - it just means that the inflation rate is steady (not accelerating/decelerating).
The Phillips Curve and the NAIRU Are Related
As I mentioned above, The Phillips Curve suggests a relationship between unemployment and inflation. However, ‘at the NAIRU’, this idea becomes moot, as inflation is stable and no longer affected by unemployment. In this sense, the Phillips Curve becomes redundant: there is no longer a trade-off between unemployment and inflation.
The Phillips Curve, the NAIRU, and Workers’ Wages
It is important to note that both the Phillips Curve and the NAIRU are based on the idea that inflation is primarily caused by the bargaining power of workers. The argument goes that workers drive inflation by demanding higher wages, which increases employers’ costs. As a result, businesses raise their prices to maintain profit margins.
This is known as ‘demand-side inflation’: workers negotiate higher wages, which not only forces up employers prices but also puts more money in their pockets which they spend on goods and services. When this increased demand is not matched by a corresponding increase in the supply of goods and services, prices go up. Neoliberal economists view this as a logical outcome of the relationship between demand and supply; both the workers’ spending their wages to purchase scarce resources and the relationship between the number of workers looking for jobs and the number of employers with vacancies.
What’s the Right Number of Unemployed People?
The NAIRU tells governments that they can avoid inflation by ensuring that just the right amount of people are out of work. The most commonly cited "right amount of unemployment to avoid accelerating inflation” is said to be in the range between 3% and 5% and in some instances above that. If you go below that, so the theory goes, inflation accelerates. Economist Larry Summers said in 2022,
“We need five years of unemployment above 5 percent to contain inflation—in other words, we need two years of 7.5 percent unemployment or five years of 6 percent unemployment or one year of 10 percent unemployment…” Economist Larry Summers
In other words, to control inflation millions of people must lose their jobs. From a neoliberal economists standpoint, as I said earlier (and no doubt will repeated often in this article) this is simply about supply and demand: as full-employment is approached that means there is a shortage of workers and that means workers have the power to demand higher wages. The solution, is to weaken workers ability to call for higher wages. How do you do that? Well one way is to increase the supply of workers by laying some of them off. If more workers are searching for work: employers have the power to set wage rates. When wages are no longer being pushed up by workers having the power to demand increases that takes pressure off the need to push up prices.
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Finding a Policy to Bring Down Inflation in the Context of the NAIRU
What policy choices do governments have to put people out of work? The chosen policy is to raise interest rates. Raising interest rates is assumed to scupper business growth by increasing the cost of business investment. Delayed business growth means employers will let workers go, increasing the number of unemployed people in the economy and reducing worker wage power. This reduces the growth of workers’ wages and their spending power in the economy. The argument is that higher interest rates will bring down inflation. This means, ‘too much money is no longer chasing too few goods and pushing up prices’.
What Does This Mean for Our Definition of ‘Full Employment’?
It means that when you hear an economist or politician on your TV say that the economy is close to full employment they are not referring to the simple definition I gave at the start of this article. i.e. that everyone who wants a job has one. They are referring to how close unemployment is to the NAIRU, i.e. the figure at which inflation will be stable. They are saying we are at full employment when up to 5% of people who want a job are not in work. The following quote is from an article by AllIanze, ‘In focus – Bank of England: First to hike, last to pause and pivot’,
“Several estimates place the medium-term NAIRU – the rate of unemployment consistent with stable wage growth – at 4.5% (against 3.8% currently and 4% expected at year-end).” Allianz SE | Munich | May 11, 2023
In the UK the NAIRU is regarded as being somewhere between 3% an 5%.
Looking at the BoE’s own publications, the NAIRU is consistently mentioned as a touchstone for interest rate policy decisions. In this context full employment always means that a large number of people, who want a job in the UK, are unable to find one.
We Are at Full Employment, Yet Not Everyone Has a Job
The orthodox definition also ignores the percentage of people who are underemployed, i.e. they are in part time work but would rather have a full-time job. And ignores people who would work if they had appropriate training and support.
So again, whenever you hear a journalist or an economist use the phrase ‘full employment’ they are not talking about everyone who wants a job having one. Whether they are conscious of it or not, they are always ‘baking in’ a certain level of unemployment and underemployment.
But Wait a Minute, Are All of These Assumptions and Theories a Reflection of Reality?
Is there a relationship between the level of unemployment and inflation? Is the NAIRU a real thing? Does raising interest rates bring down inflation? Does full employment mean that 3 to 5% of workers must be unemployed?
These are assumptions and theories put forward orthodox/neoliberal economics and they are all contested. They are not regarded as universal truths by all schools of economics—and certainly not by supporters of MMT. Let’s examine these assertions.
Is There a Relationship Between the Level of Unemployment and Inflation? Is the NAIRU a Real Thing?
What does the data show?
The data does show that over the very long run there may well be a relationship between workers’ wages and inflation. i.e. over a period of say, 100 years. However, it is not necessarily true in the short or medium term. For example, if you want to disprove the theory, track unemployment and inflation on a graph for the years 2000 thru 2015.
There is no clear correlation between the level of unemployment and the level of inflation shown on the graph above. In fact, in general, they seem to mirror each other: inflation and employment go up together and then down together. And, of course, there is the famous stagflation of the 1970s when both inflation and unemployment were high at the same time - resoundingly refuting the basis of the Philips Curve.
On the other hand, if you want to demonstrate the correlation, then track both inflation and employment for the US in the years 1978 thru 2011.
The lesson to take from this is that whatever you want to prove, either for or against a correlation, there is an appropriate period in history you can use to back up your argument.
What We Can Say Is That There Is No Consistent Relationship Between the Level of Unemployment and Inflation
Clearly, we can’t say that the relationship between levels of employment and inflation is self evident. However, Neoliberal economists continue to assume this to be the case and design policies around it.
Do Interest Rate Rises Bring Down Inflation?
MMT advocates are not convinced that raising interest rates will necessarily bring down inflation. In fact they are inclined to think that it may actually drive inflation upwards. They think this for the following reasons:
First, the cost of borrowing is an input cost to business, just as wages are. Why would one input cost lead a business to putting up prices and another not? Why choose workers’ wages as the variable to focus on rather than the cost of money? How do you reduce the cost of money? You put interest rates down not up.
Secondly, high interest rates puts additional money into the private sector, via the accounts of savers and via the higher interest governments pay on their debt. It’s likely that some of that additional money is spent into the economy. And as we know; increased demand, when not met with increased supply, creates inflation. So, although there is evidence that increased interest rates, over a certain period of time, tackle inflation, there is just as much evidence (or more) saying that increased interest rates create even greater inflation.
And here’s something I’ve not seen mentioned anywhere. The growth of savings is exponential - due to compound interest. Why? Well because each period's interest is calculated based on the growing total (principal + previously earned interest). The higher the interest rates - the faster a savers capital will growth. Keep those high interest rates over a long period of time - and that mounts up to a lot of cash. So, the more the central bank puts interest rates up (thinking they are bringing down inflation faster), the greater the amount savers will earn. We can assume that at some point savers will feel so flush that they will consider spending some of their windfall into a, potentially overheating-heating economy.
It Is Not Only Demand-Side Issues That Cause Inflation
Orthodox economists have a tendency to concentrate on demand side factors. When in fact, it may be the case that most inflation is caused by supply side factors such as increased energy costs, natural disasters/wars that cause shortages of vital business inputs and price gouging by large corporations.
Even if raising interest was an effective solution for demand side issues (MMT advocates are not convinced), it is not necessarily an effective solution for supply side issues.
For example, if the country’s energy supply is disrupted by war or a pandemic that shuts ports, it would be more logical to plan for greater energy independence than to increase interest rates. Why not invest in building up your country’s renewable energy capability to mitigate against future disasters or examine the robustness of your supply chains to ensure they are not so easily disrupted.
Does the Risk of Inflation Mean That 3 to 5% of Workers Must Be Unemployed?
MMT advocates say that there is no need to throw a large percentage of people out of work. Instead, it’s more effective to focus on the specific drivers of inflation, such as resource constraints, monopoly pricing and geopolitical shocks. And a a Job Guarantee Program that ensures both full employment and price stability.
Inflation and the MMT Job Guarantee Program
As I outline in my article on The MMT Job Guarantee Program (JGP), the program was originally developed by Bill Mitchell principally as a price stabilisation program.
“A Job Guarantee is an important part of a new order but it should really be just a very small part of the policy offerings, which I think is a point that is missed by those who think of it as a job creation program rather than the way I conceived of it initially in 1978 as a price stabilisation framework with the added advantage that jobs replaced unemployment.” Bill Mitchell - Some historical thinking about the Job Guarantee
The JGP directly targets underutilised resources. Workers carry out tasks that are not being provided by the private sector thus reducing competition for resources.
The JGP promotes full employment, ensures workers do not lose their work habits or their skills and it mitigates against the poverty and mental health issues associated with unemployment. The JGP helps manage inflation by anchoring wages to the minimum wage paid to workers on the program, which stabilises demand and reduces structural unemployment. And it does all of this while avoiding resource competition, i.e. employers competing for the most valuable unemployed workers by offering higher wages. It also acts as an automated stabiliser for the economy: workers only remain in the program during downturns and automatically return to private sector jobs as the economy recovers. It is, therefore, counter-cyclical in relation to the health of the economy.
How Does Modern Monetary Theory (MMT) Define Full Employment?
Modern Monetary Theory defines full employment as a state where everyone who wants a job (at the wage rate offered) has one—either in the private sector or through a government-funded job. Importantly, MMT rejects the concept of NAIRU, arguing that inflation is not inherently tied to low unemployment but rather to real resource constraints.
This simple definition of full employment can be achieved through a Job Guarantee Program, which also ensures price stability by setting a floor on wages and managing inflation through resource allocation rather than unemployment.
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Thanks,
Jim
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