How to get America to full employment — and fast

Monetary policy is one of the most important aspects of our world. It is also among the most misunderstood.

This is not some esoteric lesson. Few things matter more than monetary policy. For instance, more than 70 years after the Great Depression, it is commonly agreed upon by economic historians that disaster could have been avoided if the U.S. Federal Reserve had known what it was doing in the wake of the 1929 Wall Street crash. And many historians think that without the Great Depression, the rise of Hitler would not have happened. Oops.

Monetary policy matters a lot (it can drive up inequality and inflate asset bubbles, among many other things). But the money supply is sort of like the oxygen supply: You don't think about it unless there's a problem with it.

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Since the financial crisis of 2008, it has mostly been monetary policy, not fiscal or regulatory policy, that has been driving macroeconomic events. And on this score, many people are full of misconceptions.

The general outline of how the money supply affects the economy is fairly easy to grasp. At any given point in time, a country's economy has a certain amount of productive capacity (the capacity to produce certain goods and services) and a certain amount of money (there is a finite amount of dollars that exist). If the quantity of money is higher than the total productive capacity, that money will drive prices higher across the board — we call that inflation. If the quantity of money is too low, however, people will not have enough money to buy the goods and services they want. As a result, factories and companies won't produce as much as they could — and you get low growth and high unemployment. So if you have full employment and high inflation, you know the money supply is too high. If you have low employment and low inflation, you know the money supply is too low.

Today, the money supply is too low.

But, wait a second, you might say: Hasn't the Fed been pumping trillions and trillions of dollars into the economy? Hasn't this created a massive stock market boom? Are you saying we should do more?

Here's where the misconceptions come in. Technically speaking, the Fed hasn't "pumped" much of anything into the economy. Yes, through its program called "quantitative easing," the Fed has been creating money out of thin air and using it to buy U.S. government bonds. But because the Fed has been using this money to buy bonds that are simply kept on its balance sheet, there is no net money creation. The Fed takes one dollar out of circulation for each one it creates.

The Fed policies have probably had an impact — after all, we are not in a Great Depression — but most likely in an indirect way. The QE program probably served as a signal to the stock market and banks and large companies that the Fed was determined to keep things easy. This and rising stock prices probably encouraged some more investment than there would have been otherwise. But it is a very inefficient, puny, and roundabout way to go about it. What's more, it is highly inegalitarian. This, not tax cuts, is real "trickle-down economics": Make rich people feel better and maybe they'll feel richer and maybe spend more money.

There is a much easier way to go about our monetary policy — one that is both more efficient and more egalitarian. The government should cut payroll taxes on lower-income jobs, lowering the prices of hiring people and thereby increasing employment. This should be funded directly by Fed-printed money (not bonds bought by Fed-printed money), thereby directly increasing the money supply. This would kill two birds with one stone: It would guarantee that new money is pumped directly into the economy, and not highly circuitously; and this new money creation would go directly to workers who need it the most, not to the richest people first and then maybe trickling down to everyone else.

In fact, you could do it just with a computer. Set a dual target for inflation and unemployment; keep printing money and cutting taxes (even to a negative rate, potentially) as long as those targets aren't met; if inflation gets out of hand, cut down on the printing. Or, instead of a dual inflation and unemployment target, the Fed could set up what is called a level target for nominal GDP, which would have roughly the same effect. In both cases, ensuring money creation through payroll tax cuts ensures that the money is injected directly into the economy in a more egalitarian, work-promoting, controlled way.

The point is that we could actually get what we want out of our monetary policy: control over inflation and unemployment, and less inequality. All we need is to start thinking a little bit out of left field.