TJP

The argument by Washington’s political elites that keeping the Bush era tax rates create jobs is a deceptive narrative. The  Bush era tax rates introduced in 2001 failed to prevent the recession of 2008. So, if they were incapable of creating enough jobs since 2001, why would they create jobs in the future?

It is not tax cuts that create jobs. If that were the case, many Third World countries without a tax structure would have excess employment, but they do not.

Jobs are a function of income. If the income of the population cannot support products and services produced, then excess inventory will occur and production will be curtailed.

Therefore, it is deficient income that adversely affects the demand for goods and services. Lack of demand prevents entrepreneurs from expanding and creating new business..

Clearly, the principal causation of the recession was not sub-prime loans or high taxes, it was insufficient income. And, when politician and pundits misdiagnose problems, it leads to incorrect solutions and the inability to solve the problems.

The Federal Reserve (Fed) and the banking system could have used monetary policy to increase the money supply in circulation and hence increase output (income) and employment through credit expansion. However, the Fed was too busy fighting the ghost of inflation, with its infamous policy of inflation targeting (IT).

When the Fed fights inflation, it reduces the real money supply, and hence output (income) and employment fall.

The wealth constraint is a relationship between the real cash balances and real interest bearing assets (i.e. bonds, housing, and so on) of individuals. For instance, if an individual has $1,000, she can choose to hold $500 in cash and $500 in bonds, or  in any other proportion. Therefore, her real wealth (W/P) is her budget constraint, which is equal  to her demand for real balances (L) and her demand for real bonds (V) or W/P = L + V.

On the other hand, the total amount of real financial wealth (W/P) in the economy is equal to the real stock of money in the economy (M/P) and real stock of financial bearing assets (V^S) or W/P = M/P + V^S.

Thus, the sum of individuals’ real wealth is equal to the total wealth in the economy or L + V = M/P + V^S. Combining equal terms on the same side leads to (L –M/P) = (V^S – V).

From (L –M/P) = (V^S – V) we can see that if the real money supply (M/P) is less than the demand for real balances (L), the term in the left parenthesis would be positive and hence the term in the right parenthesis would also be positive, implying that the supply of real interest bearing assets (V^S) would exceed the demand (V).

When the supply of real interest bearing assets exceeds the demand for real interest bearing assets (V), prices fall (i.e., housing). In the absence of an increase in the real money supply by the Fed and increase lending by the banking system, demand is insufficient leading to a slowdown in the economy.

Certainly, maintaining the existing Bush tax rates for average citizens would maintain disposable income, but they will not create anymore jobs than they created when introduced in the rare Memorial Day session in 2001. And, it is deceptive to argue that keeping the tax rates for the wealthy would create jobs. How? Entrepreneurs, wealthy or not, would be foolish to invest in the absence of effective demand.

The simple answer to the economic crisis is to expand the money supply and Bernanke has finally recognized it. However, three players are necessary to expand the money supply, the Fed, banks, and willing borrowers.

The problem, however, is that pundits blamed the banks for perceived imprudent lending. As a result, banks have become averse to consumer credit. Moreover, the crisis has adversely affected the wealth and credit score of willing borrowers. Thus, lack of bank lending has prevented rapid monetary expansion and the growth of effective demand, as well as, output and employment.

If banks continue to be risk averse to consumer credit, the Fed should find ways to bypass the banking system and lend directly to the public.

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