TJP

Politicians and pundits often talk about job creation. However, seldom, if ever, they describe the mechanism responsible for job creation. Some Democrats believe that fiscal stimulus (government spending) is the answer to job creation. Some Republicans adhere to a different type of fiscal stimulus, tax cuts. And, many pundits argue that spending restraints will lead to economic prosperity.

Politicians and pundits fail to recognize that the monetary base is the engine of job creation.

Lets image an eight-person economy with four working adults and four non-employed teenagers. Our imagined economy has a banking (The Federal Reserve and banks) system and a foreign sector (China and Saudi Arabia). The total amount of money in our imagined economy is $100,000 and the government collect 25 percent in taxes.

The average yearly earning for the four working adults is $25,000 (=$100,000/4). Lets assume that the economy incurs a yearly trade deficit (energy and goods) of $25,000 and that the banking system does not increase the money supply.

Thus, with the outflow of $25,000, the money remaining in the economy is now $75,000. However, the four working adult are earning $100,000. Therefore, with a lower overall income it would be necessary to lay off one of the adults or reduce their wages and there is not sufficient money (income) to hire any of the unemployed teenagers. Furthermore, if the government uses all of the tax revenues for stimulus, the monetary would not increase.

Additionally, if there were war expenditures, the economy would suffer additional outflows, which would further diminish the fixed monetary base.

The monetary base is control by the banking system. And, money is more than a medium of exchange; it radically changes the characteristics of the production process. Therefore, when it is withheld from the public, effective demand diminishes.

The Federal Reserve (Fed) is an independent government body that controls the money supply. It is the issuer of currency, the regulator of banks, and the lender of last resort to banks in trouble.

The Fed influences the economy by controlling the quantity of deposits in the banking system, and thus the quantity of money or monetary base. It uses the Federal Open Market Committee (FOMC) to carry out open market operations to add or subtract reserves in the banks by buying or selling U.S. Treasury securities.

The Fed has legal authority to issue new money. Therefore, it increases the money supply by buying U.S. Treasury bonds with money that did not exist before. Conversely, it decreases the money supply buy selling securities. When the Fed buys securities, the new money goes into the banking system increasing the monetary base.

When the banks provide credit to consumers, business, and entrepreneurs effective demand increases and business hire additional labor. Thus the mechanism for job creation is optimal expansion of the monetary base.

The responsibility of the Fed is to work in conjunction with banks optimally grow the monetary base to maintain maximum level of employment and stable prices and moderate interest rates. Therefore, when an economy fails it means that the monetary authorities failed to exercise their responsibilities.

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