[Rushtalk] How the Fed Fuels Unemployment

Carl Spitzer lynux at keepandbeararms.com
Tue May 17 17:37:51 MDT 2016

                     How the Fed Fuels Unemployment
                         by Thomas J. DiLorenzo
                        by Thomas J. DiLorenzo 
        Recently by Thomas DiLorenzo: Another Court Historian’s
                          False Tariff History

Testimony of Dr. Thomas DiLorenzo
Professor of Economics, Loyola University Maryland
Committee on Financial Services, Subcommittee on Domestic Monetary
Policy and Technology
Wednesday, February 9, 2011
2128 Rayburn House Office Building

Mr. Chairman and members of the committee, I thank you for the
opportunity to address the issue of today’s hearing: "Can Monetary
Policy Really Create Jobs?" Since I am an academic economist, you will
not be surprised to learn that I believe that the correct answer to this
question is: "yes and no." Monetary policy under the direction of the
Federal Reserve has a history of creating and destroying jobs. The
reason for this is that the Fed, like all other central banks, has
always been a generator of boom-and-bust cycles in the economy. Why this
is so is explained in three classic treatises in economics: Theory of
Money and Credit by Ludwig von Mises, and two treatises by Nobel
laureate economist F.A. Hayek: Monetary Theory and the Trade Cycle and
Prices and Production. Hayek was awarded the Nobel Prize in Economic
Science in 1974 for this work. I will summarize the essence of this
theory of the business cycle as plainly as I can. 

When the Fed expands the money supply excessively it not only is prone
to creating price inflation, but it also sows the seeds of recession or
depression by artificially lowering interest rates, which can ignite a
false or unsustainable "boom" period. Lower interest rates induce people
to consume more and save less. But increased savings and the subsequent
business investment that it finances is what fuels economic growth and
job creation.

Lowered interest rates and wider availability of credit caused by the
Fed’s expansionary monetary policy causes businesses to invest more in
(mostly long-term) capital projects (primarily real estate in the latest
boom-and-bust cycle), and there is an accompanying expansion of
employment in those industries. But since the lower interest rates are
caused by the Fed’s expansion of the money supply and not an increase in
savings by the public (i.e., by the free market), businesses that have
invested in long-term capital projects eventually discover that there is
not enough consumer demand to justify their investments. (The reduced
savings in the past means consumer demand is weaker in the future). This
is when the "bust" occurs. 

The economic damage done by the boom-and-bust policies of the Fed occur
in the boom period when resources are misallocated in the ways described
here. The "bust" period is actually a necessary cure for the economic
miscalculations that have occurred, as businesses liquidate their
unsound investments and begin to make decisions on realistic,
market-based interest rates. Prices and wages must return to reality as

Government policies that bail out businesses that have made these bad
investment decisions will only delay or prohibit economic recovery while
encouraging more of such behavior in the future (the "moral hazard
problem"). This is how short recessions can be turned into seemingly
endless ones. Worse yet is for the Fed to create even more monetary
inflation, rather than allowing the necessary economic adjustments to
take place, which will eventually set off another boom-and-bust cycle.

As applied to today’s economic situation, it is obvious that the
artificially low interest rates caused by the policies of the Greenspan
Fed created an unsustainable boom in the housing market. Thousands of
new jobs were in fact created – and then destroyed – giving an updated
meaning to Joseph Schumpeter’s phrase "creative destruction." Many
Americans who obtained jobs and pursued careers in housing construction
and related industries realized that those jobs and careers were not
sustainable after all; they were fooled by the Fed’s low interest rate
policies. Thus, the Fed was not only responsible for causing the massive
unemployment that we endure today, but also a great amount of what
economists call "mismatch" unemployment. The skills that people in these
industries developed were no longer in demand; they lost their jobs; and
now they must retool and re-educate themselves.

The Fed has been generating boom-and-bust cycles from its inception in
January of 1914. Total bank deposits more than doubled from 1914 to 1920
(partly because the Fed financed part of the American involvement in
World War I) and created a false boom that turned to a bust with the
Depression of 1920. GDP fell by 24% from 1920–1921, and the number of
unemployed more than doubled, from 2.1 million to 4.9 million (See
Richard Vedder and Lowell Galloway, Out of Work: Unemployment and
Government in Twentieth-Century America). This was a more severe
economic decline than was the first year of the Great Depression. 

In America’s Great Depression economist Murray N. Rothbard demonstrated
that, once again, it was the excessively expansionary monetary policy of
the Fed – and of other central banks – that caused yet another
boom-and-bust cycle that spawned the Great Depression. It was not the
Fed’s subsequent restrictive monetary policy of 1929–1932 that was the
problem, as Milton Friedman and others have argued, but its previous
expansion. The Fed was therefore guilty of contributing greatly to the
massive unemployment of the Great Depression. 

In summary, the Fed’s monetary policies tend to create temporary and
unsustainable increases in employment while being the very engine of
recession and depression that creates a much greater degree of job
destruction and unemployment.

                                                       February 10, 2011

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