Academic journal article
By Mitchell, William F.
Journal of Economic Issues , Vol. 32, No. 2
Governments redistribute resources from private households to the public sector to advance a variety of collective actions. The desirable size of the government (and the amount of resources redistributed) is a political choice, rather than an economic issue. The question for economists is how government goes about its role once its scale is accepted. In this paper, I examine this role as it relates to unemployment. High and persistent unemployment has pervaded almost every OECD country since the mid-1970s. I argue that unemployment arises because the budget deficit is too small relative to the desires of the private sector to meet its tax obligations and to save and to hold money for transactions purposes.
Mass unemployment is a macroeconomic phenomenon and can never be a "real wage" problem. William Viekrey  argued that "the 'deficit' is not an economic sin but an economic necessity. Its most important function is to be the means whereby purchasing power not spent on consumption, nor recycled into income by the private creation of net capital, is recycled into purchasing power by government borrowing and spending. Purchasing power not so recycled becomes non-purchase, non-sales, non-production, and unemployment."
The rapid inflation of the mid-1970s left an indelible impression on policymakers who became captives of the resurgent new labor economics and its macroeconomic counterpart, monetarism. The goal of low inflation replaced other policy targets, including low unemployment. This has resulted in GDP growth in OECD countries that has generally been below that necessary to absorb the growth in the labor force in combination with rising labor productivity.(1) The proximate cause of high unemployment has thus been the excessively restrictive fiscal and monetary policy stances by OECD governments driven by what we might call "backward" thinking [Mitchell 1996; 1998]. Backward reasoning reflects a fundamental misunderstanding of the way fiat currency operates. It begins with the fallacious analogy that government spending, taxation, and debt issue is equivalent to the spending and financing decisions of the household. Accordingly, governments are supposed to seek financing prior to spending. The analogy has led orthodox economists to advocate balanced budgets to avoid higher tax rates and interest rates. But the underlying cause is that the reemerging free market ideology has convinced us wrongly that government involvement in the economy imposes costs on us, and we have thus supported governments that have significantly reduced their fiscal involvement in economic activity.
The economies that avoided the plunge into high unemployment maintained a "sector of the economy which effectively functions as an employer of the last resort, which absorbs the shocks which occur from time to time . . ." [Ormerod 1994, 203]. In this paper, I characterize this absorption function in terms of the Buffer Stock Employment (BSE) model. I will briefly outline the BSE approach and compare and contrast the inflation control mechanisms of the BSE model with those in an economy subject to a NAIRU.(2) I provide a more complete treatment of the financial implications of the BSE model elsewhere [Mitchell 1998].
I demonstrate three ways in which government can maintain price stability. First, it can adopt the NAIRU approach by suppressing the budget deficit and generating unemployment. Second, it can conduct a BSE policy whereby the public sector absorbs all the current idle workers into paid employment at a base level wage that it sets and maintains. I will show that the relevant price stability concept can be called the NAIBER.(3) The change in the buffer employment ratio (BER)(4) disciplines the wage-price pressures in the private sector by asserting the buffer stock wage as the numeraire. A third approach is a special case of the BSE policy. The government may not wish to let the market drive the BER high enough to equal the NAIBER and can intervene using an income policy to maintain a lower than otherwise BER while still maintaining price stability. …