A note on the sustainability of full employment in the presence of budget deficits

ABSTRACT

In a recent issue of this journal, Tymoigne and Wray, as well as Palley, discussed whether economies can experience stable full-employment equilibria with persistent public budget deficits. This implies continuous growth of a stock-variable: high-powered money and/or government bonds in the hands of the private sector. Their discussion assumed a stationary state. The question is whether such a situation can be regarded as sustainable over time. This paper argues that a satisfactory solution to the problem can be found only by abandoning the hypothesis of stationary state and considering the effects that different compositions of public expenditure have on the rate of growth. To have a stable full-employment equilibrium with budget deficits, the economy must grow. Since the economy is assumed to be in full employment, the growth of aggregate output must be entirely due to the growth of productivity, which can be realized by changing the composition of public spending in favor of productive expenditures.

KEYWORDS:

• Full employment
• public deficits
• public debt
• growth

JEL CLASSIFICATION:

• E6
• H5
• O4

Acknowledgments

I wish to thank the Journal's referees, F. Patriarca and L. Zamparelli for their helpful comments and suggestions. The responsibility for any remaining possible mistake is solely mine.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹Because of the hypothesis of a full-employment stationary state, must be equal to replacement investment, say .

²Under the specific stationary state hypothesis, is also constrained in another sense. Total government outlays must be entirely devoted to current spending; if any share of were devoted to capital expenditures, the economy would be pulled off its stationary state.

³See Palley (2015a, pp. 10–13) and Palley (2015b, pp. 53–54).

⁴To take account of this, Palley adopts a modified Phillips curve, , where is the ratio of high-powered money to GDP. Increases in can determine higher expected inflation and, hence, higher current inflation. For Palley, inflation can also start before full employment is reached because of sectoral bottlenecks.

⁵Tymoigne and Wray (2015, p. 32) also maintain that, for stability reasons, it is preferable to have a creditor rather than borrower private sector.

⁶Here, the non-validity of the Barro theorem is assumed, so that the stock of state liabilities held by the private sector is regarded as wealth.

⁷For simplicity, we abstract from short-period J-effects.

⁸This could happen regardless of the real possibility that the state actually defaults. A conventionally established conviction that a state is on the verge of a default can be sufficient to bring about an increase in risk premia. On this see also Pasinetti (1997).

⁹This essentially is the case contemplated by Palley (2015a).

¹⁰Which is the one usually considered in the mainstream literature.

¹¹See also Sardoni (2011).

¹²For simplicity, productive expenditures can be thought of as public investment, as opposed to current expenditures seen as unproductive, even though Domar was careful to point out that this classification might be misleading (Domar 1944, p. 820).

¹³ , of course, may well be equal to zero.

¹⁴If is increasing in , it would reach its maximum when it is , i.e. when . Here, however, we assume that must remain positive, that is to say that some public expenditure with no positive impact on productivity must be made by the government. This amounts to assuming that the general role played by the state in a modern society implies that it must also make expenditures that do not have measurable economic effects in terms of productivity.

¹⁵See the Appendix for the determination of such a solution under the hypothesis of a specific functional relation between and .