Federal Reserve’s Full Employment Myth

Proposed legislation would dampen the myth that a central bank can increase employment. Federal Reserve[1] has two general mandates: maximize employment and stabilize prices. The Sound Dollar Act, sponsored by Kevin Brady, would remove the employment mandate because it allows Federal Reserve to print dollars for new loans, and these dollars bid up prices. Even worse, employment does not rise overall; the central bank only moves jobs from one sector to another.

Here’s how prices rise:

  1. To create jobs, Federal Reserve issues new dollars and lends them to the U.S. government, banks, and other entities.
  2. The recipients of these new dollars hire people, hence new jobs.
  3. The newly-employed people buy products and services, and since the marketplace is a big, slow auction, their purchases bid up prices.

As for long-run employment, it does not change. For every job created with the new dollars, another job is lost. Company A receives newly issued dollars through a bank loan or government grant and hires more people. However, Company B, which does not take out a loan, lays off people when prices for materials rise, leaving less money for salaries, all due to the influx of new dollars given to Company A. Moreover, Company A may also be surprised by the higher prices and may lay off some of the newly hired workers.

Even worse, Federal Reserve likely increases long-term unemployment because the new dollars create bubbles followed by periods of high unemployment, as shown with the dotcom and housing bubbles. The housing boom attracted workers from other industries. When the recession arrived, these people were laid off and needed months or years to find new jobs; some are still looking. The Federal Reserve’s mandate for full employment often leads to massive unemployment.

The myth that a central bank can create jobs loses its allure if we keep things simple. Federal Reserve can only create dollars; it doesn’t build factories, create new products, or pool money from other investors like a venture capital fund.

Creating dollars is like a company issuing more shares. Those who receive the new shares or dollars are better off but all other shareholders or people holding dollars will lose wealth, because their shares or dollars are worth less. Creating more dollars is a shady accounting maneuver, not a long-term job creator.

The current Federal Reserve approach of stable prices and maximum employment is called a “dual mandate.” It would be more accurate to call it a “dual failure.” New dollars issued by Federal Reserve bid up prices while long-term unemployment either stays the same or increases. Congressman Brady’s bill will remove the full-employment mandate and help to dispel the myth that central banks can increase overall jobs.

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