Buffer Stocks: A Simpler Diagram

Figure 1: Overly complex depiction of how a buffer stock works. From http://learneconomicsonline.com/bufferstock.php

The basic model

In a buffer stock, the buffer stock operator stabilizes the price of a good within a range, by choosing a “sell price” and a “buy price” that form the top and bottom of that range. We’ll start by assuming there’s some standard downward-sloping demand curve out there. Above the buy price we will leave it be, but if the market price hits the buy price, then the scheme operator will jump in to buy whatever is necessary to keep the price from falling lower. Since these purchases contribute to demand, that gives us a combined demand curve that looks like this:

Figure 2: Demand curve that includes a buffer stock operator who will buy in unlimited quantities at an announced buy price.
Figure 3: Supply curve which includes a buffer stock operator who will sell in unlimited quantities at an announced sell price.
Figure 4: Basic model of a buffer stock scheme.
Figure 5: Market demand curve shifts to the left, forcing the buffer stock to buy the commodity.
Figure 6: Market supply curve shifts to the left, forcing the buffer stock to sell the commodity.

Fiddling with prices

We could also ask questions about the relationship between the buy and sell prices. The gap between the buy and sell prices forms a ‘corridor,’ and the scheme operator can set this corridor as wide/narrow as they please, which would translate to looser/tighter control over the price. But what if they switched the prices, so that the buy price was higher than the sell price? Then things get dicey.

Figure 7: The buffer stock operator sets the sell price below the buy price. This creates a risk-free profit opportunity for other traders, who can make money by buying the good from the buffer stock and then selling it right back to the buffer stock. The ‘equilibrium quantity’ then is infinite, at least until the scheme breaks.
Figure 8: The buffer stock operator sets the buy and sell prices to be equal. However in this case, the market equilibrium without the buffer stock also happens to equal that price.
Figure 9: The buffer stock operator selling the commodity in order to maintain the market price at its target price.
Figure 10: The buffer stock operator buying the commodity in order to maintain the market price at its target price.

Further comments

So that’s the model. Before we go though I want to add some discussion that will paint a fuller picture.

What’s a commodity anyway?

Above I was writing as if the scheme is always to stabilize the price of some commodity like grain or corn on one side, against money being used to buy it on the other. But of course it doesn’t have to be this way. For one thing, the point might be more to stabilize the value of the money rather than the commodity — this is exactly how the gold standard worked, with the government buying and selling gold in order to lock the value of the currency to a particular amount of gold.

Whose operation is it anyway?

We’ve been tacitly assuming some sort of auction mechanism, which makes the idea of supply and demand curves, as well as a price that adjusts to equate supply and demand, a lot more plausible. However, it would really suck to be a buffer stock operator if you actually had to participate in an auction mechanism that forced you to specify a quantity rather than a price. That’s because without knowing exactly what the market supply and demand are, you don’t know what quantities would be needed to move the auction price to be within your corridor. You have to guess, and you’ll probably guess wrong. The result is that the price probably would not stay within the corridor at all times.

Central bank interest rate targets

If you follow monetary policy (skip this section if you don’t), then you’ve probably seen a graph that looks like figure 11, depicting how a central bank can use a “corridor system” to hit its interest rate target in the inter-bank lending market:

Figure 11: Corridor system for central bank interest rate targets. From The Macroeconomic Effects of Student Debt Cancellation: Appendix C —Digression of the Fed’s Operations, by Scott Fullwiler.

The Job Guarantee and other one-way buffer stocks

Besides using buffer stocks as a descriptive model to make sense of existing institutions like fixed exchange rates and interest rate targets, MMT also applies the concept analogically for understanding the neoliberal approach to fighting inflation. Briefly, that strategy has been to use policy (primarily interest rate adjustments) to keep unemployment above a certain level (called the NAIRU, or Non-Accelerating Inflation Rate of Unemployment), on the basis that high unemployment would make it hard for workers to bargain for higher wages, which would then keep costs and therefore prices down. Because this method relies on an adjusting pool of unemployed people to stabilize prices, MMTers refer to this strategy as an unemployment buffer stock.

Figure 12: A buffer stock where there is only a buy price, no sell price. This graph can be used loosely to understand how a Job Guarantee works. (But in general, don’t use supply and demand models to understand the labor market!!!) The government uses AD management policy to keep the demand curve sufficiently far to the left that the price of basic labor always equals the JG wage.

Conclusion

Buffer stocks aren’t just a niche piece of agricultural economics; they are a powerful tool for understanding macroeconomics. And if we’re going to place them so prominently in our explanation, we ought to have a clear, simple diagram that gives some intuition about how they work, so that’s what I’m offering here. While there are dangers of indiscriminately throwing supply & demand graphs around, this buffer stock model is still useful for wrapping your head about things like bank deposits, fixed exchange rates, and the Job Guarantee.

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