TJP

The problem that confronts the U.S. Economy is how to maintain full employment or how to produce the required domestic income to maintain full employment. Clearly, if current income produces unemployment, more income is necessary to produce full employment.

The public, and rightly so, judges government policies by their effects on employment. And, thus far, the policies of the Obama administration and Congress have not reduced unemployment of increased domestic income.

One can conclude, therefore, that policy makers do not know the root cause of the nation's economic problem, since their policy prescription failed to increase domestic income and reduce unemployment.

Abba Lerner in Functional Finance and Federal Debt, argued that the first financial responsibility of government is to keep total rate of spending in the country not greater or less than the rate at which current prices would purchase all goods and services produced in the country.

According to Lerner, the central idea is that government spending and taxing, borrowing and repayment of loans, issuance of new money and withdrawal of money should be undertaken to achieve full employment.

When governments fail to produce enough money to compensate for population growth rate and lost of purchasing power, effective demand diminishes and unemployment increases.

The production of money and its availability to consumers and investors leads to increased demand, which is a requirement for increasing production and reducing unemployment.

That is, without sufficient money in the hands of consumers and investors, increased production is unlikely.

The notion that production (supply) by itself creates its own demand (Say's law) is illusory. If Say's law was accurate, the production of gold lunch boxes would create demand. Of course, we do not see producers producing gold lunch boxes, because if produced there would be no demand for them.

Additionally, the argument that unemployment results form consumers not spending (hoarding) their money is equally silly. Unemployment is everywhere a monetary phenomenon; it is a result of government, the Federal Reserve (the Fed), restricting the supply of money.

The Fed is an autonomous governmental agency whose power to create employment exceeds that of the President and Congress. The Fed determines the amount of money in circulation, as well as the base interest rate. Thus, if the Fed withdraws money from the economy or increases interest rate, it inhibits productivity and employment.

Since 2003 until the fourth quarter of 2008, the Fed under Greenspan and Bernanke maintained a flat monetary growth policy. And between September and December of 2008, under Bernanke, the Fed increased the money supply by about a trillion dollars.

However, the increase was used to purchase banks' assets and to provide loans to foreign central banks. The reserve increase increase to banks was not used to expand consumer and investor credit which would have expanded effective demand.

The well intended fiscal expansion (increasing government spending) by the Obama administration, without an expansion in credit for the middle class, was unlikely to increase consumers' income, and hence effective demand.

This is easy to grasp, if we assume a four-family household economy with each family providing one member into the labor force.

Lets assume, for comparison with actual Fed performance, that the central bank in our four-household economy maintained the level of nominal money supply (M1) flat, at around $100,000 for six (6) consecutive years. During the the first year, M1 per income earner is $25,000.

Lets assume further that within the period of flat nominal monetary growth, an additional member from each household enters the labor force. With the money supply fixed, if the labor force is now eight people, the money supply per income earner would be $12,500. What does this mean?

Simple, it means that if the money supply does not increase either the earning of the existing employed individuals has to be cut or new entrants would not find work.

Now, lets assume for the sake of argument that during the period of flat nominal monetary growth that the impossible occurs and there are no new entrants into the labor force. However, there is an exogenous shock to the economy, the price of energy increases significantly. How would it affect the four family economy?

Economists distinguish between real and nominal money demand. Real money demand is unchanged when prices increase. Nominal money demand increases in proportion to the increase in the price level. When energy price rises, consumers need more nominal money to purchase the same quantity of energy.

However, if the money supply remains fixed, consumers have to reallocate outlays from other commodities to energy. As this reallocation adjustment occurs, demand for many products diminishes.

Diminished demand leads to inventory accumulation and unemployment, which is where we are. Thus, it is the Fed that got us in this mess and only by increasing the money supply and expanding credit can the economy approach the goal of full employment.

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