TJP

Modern economies cannot operate without money. Economies endowed with insufficient money have limited productive capacity and are unable to meet their employment needs.

Central banks and the banking system (commercial banks) are responsible for maintaining adequate supply of money in the economy. The performance of central banks in managing money and the banking system in managing credit determines productivity and employment growth. The money supply (M1) is currency in circulation plus demand deposits

Societies have many resources, such as land, capital, and the time of their citizens. All these resources, in particularly people, if utilized properly, produce societal benefits. However, many societies (political leaders) do not effectively use the resources in their possession. As a result, economies under their control end up with surplus labor (high unemployment).

However, if the money supply, adjusted for its income velocity (V), was adequate, modern economies would be able to exploit comparative advantages in land, capital and labor, which would lead to full employment. The income velocity of money is the number of time money is turned over per year in financing the annual flow of income.

The average aggregate full employment wages could be used to determine the value of the economy’s full employment productive capacity, which would be the full employment gross domestic product.

It is therefore possible to estimate the full employment income, as well as the nominal money supply required to achieve it. The money supply would be sufficient to cover full employment wages for all employable labor.

Gross domestic product is the economy’s income (Y) and income velocity is the ratio of nominal income to the nominal money supply. Thus, given the full employment income and the income velocity, economists can estimate the nominal money supply required for full employment.

An expansion in fiscal policy can increase income velocity if it causes interest rate to rise. However, the Federal Reserve's (Fed) propensity to keep interest rate low decreases the velocity of money. It causes money holders to use money less intensely.

If the income necessary for full employment can be estimated and high interest rate causes money to work harder, why has the Fed failed to bring about full employment? Moreover, why Congress and the President allowed the Fed and the banking system to starve the economy?

The answer is simple. Full employment does not benefit the elite, it causes wealth transfer from the rich to the less affluent by causing wages to rise.

Thus, the Fed’s inflation targeting (IT) policy is in conflict with full employment and rising wages, since restraining inflation, whether it exist or not, requires, the Fed to limit bank credit expansion.

It is clear that the Fed can pretend to be an activist entity by increasing the money supply. However, increasing the money supply without increasing credit does not improve the economy or employment; and it does not create inflation, as long as credit expansion is restrained.

The public has had difficulty separating money supply expansion and credit expansion, which are distinct entities. The Fed expands the money supply and the banking system expands credit. And, it is credit expansion that radically changes production and employment.

The Fed and Congress prevent credit expansion by paying interest on bank reserves. In essence, the Fed prints money and loan it to banks at close to zero interest rate and pays banks interest on the loaned funds. By doing so they discourage bank lending to the public and hence needed credit expansion.

The monetary expansion by the Fed is a mirage, since it does not put money into the hands of consumers.  Likewise, the Fed reduced the effectiveness of Obama’s fiscal expansion by deliberately keeping interest rate low. When interest rate is low, money turnover is also low.

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