The Federal Reserve System increases the money supply when it wants to encourage more spending in the economy, and especially when it is concerned about high levels of unemployment. Increasing the money supply usually decreases interest rates—which are the price of money paid by those who borrow funds to those who save and lend them. Lower interest rates encourage more investment spending by businesses, and more spending by households for houses, automobiles, and other “big ticket” items that are often financed by borrowing money. That additional spending increases national levels of production, employment, and income. However, the
Federal Reserve Bank must be very careful when increasing the money supply. If it does so when the economy is already operating close to full employment, the additional spending will increase only prices, not output and employment.

Effect of Monetary Policies on the U.S. Economy

The monetary policies adopted by the Federal Reserve System can have dramatic effects on the national economy and, in particular, on financial markets. Most directly, of course, when the Federal Reserve System increases the money supply and expands the availability of credit, then the interest rate, which determines the amount of money that borrowers pay for loans, is likely to decrease. Lower interest rates, in turn, will encourage businesses to borrow more money to invest in capital goods, and will stimulate households to borrow more money to purchase housing, automobiles, and other goods.

But the Federal Reserve System can go too far in expanding the money supply. If the supply of money and credit grows much faster than the production of goods and services in the economy, then prices will increase, and the rate of inflation will rise. Inflation is a serious problem for those who live on fixed incomes, since the income of those individuals remains constant while the amount of goods and services they can purchase with their income decreases. Inflation may also hurt banks and other financial institutions that lend money, as well as savers. In a period of unanticipated inflation, as the value of money decreases in terms of what it will purchase, loans are repaid with dollars that are worth less. The funds that people have saved are worth less, too.

When banks and savers anticipate higher inflation, they will try to protect themselves by demanding higher interest rates on loans and savings accounts. This will be especially true on long-term loans and savings deposits, if the higher inflation is considered likely to continue for many years. But higher interest rates create problems for borrowers and those who want to invest in capital goods.

If the supply of money and credit grows too slowly, however, then interest rates are again likely to rise, leading to decreased spending for capital investments and consumer durable goods (products designed for long-term use, such as television sets, refrigerators, and personal computers). Such decreased spending will hurt many businesses and may lead to a recession, an economic slowdown in which the national output of goods and services falls. When that happens, wages and salaries paid to individual workers will fall or grow more slowly, and some workers will be laid off, facing possibly long periods of unemployment.

For all of these reasons, bankers and other financial experts watch the
Federal Reserve’s actions with monetary policy very closely. There are regular reports in the media about policy changes made by the Federal
Reserve System, and even about statements made by Federal Reserve officials that may indicate that the Federal Reserve is going to change the supply of money and interest rates. The chairman of the Federal
Reserve System is widely considered to be one of the most influential people in the world because what the Federal Reserve does so dramatically affects the U.S. and world economies, especially financial markets.

LABOR AND LABOR MARKETS

Labor includes work done for employers and work done in a person’s own household, but labor markets deal only with work that is done for some form of financial compensation. Labor markets include all the means by which workers find jobs and by which employers locate workers to staff their businesses. A number of factors influence labor and labor markets in the United States, including immigration, discrimination, labor unions, unemployment, and income inequality between the rich and poor.

The official definition of the U.S. labor force includes people who are at least 16 years old and either working, waiting to be recalled from a layoff, or actively looking for work within the past 30 days. In 1998 the
U.S. labor force included nearly 138 million people, most of them working in full-time or part-time jobs.

Most people in the United States receive their income as wages and salaries paid by firms that have hired individuals to work as their employees. Those wages and salaries are the prices they receive for the labor services they provide to their employers. Like other prices, wages and salaries are determined primarily by market forces.

Labor Supply and Demand

The wages and salaries that U.S. workers earn vary from occupation to occupation, across geographic regions, and according to workers’ levels of education, training, experience, and skill. As with goods and services purchased by consumers, labor is traded in markets that reflect both supply and demand. In general, higher wages and salaries are paid in occupations where labor is more scarce—that is, in jobs where the demand for workers is relatively high and the supply of workers with the qualifications and ability to do that work is relatively low. The demand for workers in particular occupations depends largely on how much the work they do adds to a firm’s revenues. In other words, workers who create more products or higher-priced products will be worth more to employers than workers who make fewer or less valuable products. The supply of workers in any occupation is affected by the amount of time and effort required to enter that occupation compared to other things workers might do.

Workers seeking higher wages often learn skills that will increase the likelihood of finding a higher-paying job. The knowledge, skills, and experience a worker has acquired are the worker’s human capital.
Education and training can clearly increase workers’ human capital and productivity, which makes them more valuable to employers. In general, more educated individuals make more money at their jobs. However, a greater level of education does not always guarantee higher wages.
Certain professions that demand a high level of education, such as teaching elementary and secondary school, are not high-paying. Such situations arise when the number of people with the training to do that job is relatively large compared with the number of people that employers want to hire. Of course this situation can change over time if, for example, fewer young people choose to train for the profession.

Supply and demand factors change in labor markets, just as they do in markets for goods and services. As a result, occupations that paid high wages and salaries in the past sometimes become outdated, while entirely new occupations are created as a result of technological change or changes in the goods and services consumers demand. For example, blacksmiths were once among the most skilled workers in the United
States; today, computer programmers and software developers are in great demand.

The process of creative destruction carries over from product markets to labor markets because the demand for particular goods and services creates a demand for the labor to produce them. Conversely, when the demand for particular goods or services decreases, the demand for labor to produce them will also fall. Similarly, when new technologies create new products or new ways of producing existing products, some workers will have new job opportunities, but other workers might have to retrain, relocate, or take new jobs.

Factors Affecting Labor Markets

Changes in society and in the makeup of the population also affect labor markets. For example, starting in the 1960s it became more common for married women to work outside the home. Unprecedented numbers of women—many with little previous job experience and training—entered the labor markets for the first time during the 1970s. As a result, wages for entry-level jobs were pushed down and did not rise as rapidly as they had in the past. This decline in entry-level wages was further fueled by huge numbers of teens who were also entering the labor market for the first time. These young people were the children of the baby boom of 1946 to
1964, a period in which the birth rate increased dramatically in the
United States. So, two changes—one affecting women’s roles in the labor market, the other in the makeup of the age of the workforce—combined to affect the labor market.

The baby boomers’ effects have continued to reverberate through the U.S. economy. For example, starting salaries for people with college degrees became depressed when large numbers of baby boomers started graduating from college. And as workers born during the boom have aged, the work force in the United States has grown progressively older, with the percentage of workers under the age of 25 falling from 20.3 percent in
1980 to 14.3 percent in 1997.

By the 1990s, the women and baby boomers who first entered the job market in the 1970s had acquired more experience and training. Therefore, the aging of the labor force was not affecting entry-level jobs as it once did, and starting salaries for college graduates were rising rapidly again. There will be, however, other kinds of labor market and public policy issues to face when the baby boomers begin to retire in the early decades of the 21st century.

Immigration

Labor markets in the United States have also been significantly affected by the immigration of families and workers from other nations. Most families and workers in the United States can trace their heritage to immigrants. In fact, before the 20th century, while the United States was trying to settle its frontiers, it allowed essentially unlimited immigration. see Immigration: A Nation of Immigrants. In these periods the U.S. economy had more land and other natural resources than it was able to use, because labor was so scarce. Immigration served as one of the main remedies for this shortage of labor.

Generally, immigration raises national output and income levels. These changes occur because immigration increases the number of workers in the economy, which allows employers to produce more goods and services.
Capital resources in the economy may also become more valuable as immigration increases. The number of workers available to work with machines and tools increases, as does the number of consumers who want to buy goods and services. However, wages for jobs that are filled by large numbers of immigrants may decrease. This wage decline stems from greater competition for these jobs and from the fact that many immigrants are willing to work for lower wages than other U.S. workers.

Immigration into the United States is now regulated by a system of quotas that limits the number of immigrants who can legally enter the country each year. In 1964 Congress changed immigration policies to give preference to those with families already in the United States, to refugees facing political persecution, and to individuals with other humanitarian concerns. Before that time, more weight had been placed on immigrants’ labor-market skills. Although this change in policy helped reunite families, it also increased the supply of unskilled labor in the nation, especially in the states of California, Florida, and New York. In
1990 Congress modified the immigration legislation to set a separate annual quota for immigrants with job skills needed in the United States.
But people with family members who are already U.S. citizens remain the largest category of immigrants, and U.S. immigration law still puts less focus on job skills than do immigration laws in many other market economies, including Canada and many of the nations of Western Europe.

Discrimination

Women and many minorities have long faced discrimination in U.S. labor markets. Employed women earn less, on average, than men with similar levels of education. In part this wage disparity reflects different educational choices that women and men have made. In the past, women have been less likely to study engineering, sciences, and other technical fields that generally pay more. In part, the wage differences result from women leaving the job market for a period of years to raise children.
Another reason for the disparity in wages between men and women is that there is still a considerable degree of occupational segregation between males and females—for example, nurses are much more likely to be females and dentists males. But even after allowing for those factors, studies have generally found that, on average, women earn roughly 10 percent less than men even in comparable jobs, with equal levels of education, training, and experience.

Analysis of wage discrimination against black Americans leads to similar conclusions. Specifically, after controlling for differences in age, education, hours worked, experience, occupation, and region of the country, wages for black men are roughly 10 percent lower than for white men, though occupational segregation appears to be less common by race than by gender. Issues other than wage discrimination are also important to note for black workers. In particular, unemployment rates for black workers are about twice as high as they are for white workers. Partly because of that, a much lower percentage of the U.S. black population is employed than the white population.

Hispanic workers generally receive wages about 5 percent lower than white workers, after adjusting for differences in education, training, experience, and other characteristics that affect workers’ productivity.
Some studies suggest that differences in the ability to speak English are particularly important in understanding wage differences for Hispanic workers.

The differences between the earnings of white males and earnings of females and minorities slowly decreased in the closing decades of the
20th century. Some laws and regulations prohibiting discrimination seem to have helped in this process. A large part of those gains occurred shortly after the adoption of the 1964 Civil Rights Act, which among other things, outlawed discrimination by employers and unions. Many economists worry that the discrimination that remains may be more difficult to identify and eliminate through legislation.

Discrimination in competitive labor markets is economically inefficient as well as unfair. When workers are not paid based on the value of what they add to employers’ production and profit levels, society loses opportunities to use labor resources in their most valuable ways. As a result, fewer goods and services are produced. If employers discriminate against certain groups of workers, they will pay for that behavior in competitive markets by earning lower profits. Similarly, if workers refuse to work with (or for) coworkers of a different gender, race, or ethnic background, they will have to accept lower wages in competitive markets because their discrimination makes it more costly for employers to run their businesses. And if customers refuse to be served by workers of a certain gender, race, or ethnicity in certain kinds of jobs, they will have to pay higher prices in competitive markets because their discrimination raises the costs of providing these goods and services.

Those who are discriminated against receive lower wages and often experience other forms of economic hardship, such as more frequent and longer periods of unemployment. Beyond that, the lower wage rates and restricted career opportunities they face will naturally affect their decisions about how much education and training to acquire and what kinds of careers to pursue. For that reason, some of the costs of discrimination are paid over very long periods of time, sometimes for a worker’s entire life.

It is clear that there is still discrimination in the U.S. economy. What is not always so clear is how much that discrimination costs the economy as a whole, and that it costs not only those who are discriminated against, but also those who practice discrimination.

Unions

Many U.S. workers belong to unions or to professional associations (such as the National Education Association for teachers) that act like unions.
These unions and associations represent groups of workers in collective bargaining with employers to agree on contracts. During this bargaining, workers and employers establish wages and fringe benefits, such as health care and pension benefits, for different types of jobs. They also set grievance procedures to resolve labor disputes during the life of the contract and often address many other issues, such as procedures for job transfers and promotions of workers.

Many studies indicate that wages for union workers in the United States are 10 to 15 percent higher than for nonunion workers in similar jobs and that fringe benefits for union workers also tend to be higher. That compensation difference is an important consideration both for workers thinking about joining unions, and for employers who are concerned about paying higher wages and benefits than their competitors. In some cases, it appears that the higher wages and benefits are paid because union workers are more productive than nonunion workers are. But in other cases unions have been found to decrease productivity, sometimes by limiting the kinds of work that certain employees can do, or by requiring more workers in some jobs than employers would otherwise hire. Economists have not reached definite conclusions on some of these issues, but it is evident that there are many other broad effects of unions on the economy.

Unions and collective bargaining in the United States are markedly different from such organizations and procedures in other industrialized nations. U.S. unions generally practice what is often described as business unionism, which focuses mainly on the direct economic interests of their members. In contrast, unions in Europe and South America focus more on influencing national policy agendas and political parties.

The different focus by U.S. unions partly reflects the special history of unions in the United States, where the first sustained successes were achieved by craft unions representing skilled workers such as carpenters, printers, and plumbers. These skilled workers had more bargaining power and were more difficult for employers to replace or do without than workers with less training. Unions representing these skilled workers were also able to provide special services to employers that allowed both the unions and employers to operate more efficiently. For example, craft unions in large cities often ran apprenticeship programs to train young workers in these occupations. And many craft unions operated hiring halls that employers could call to find trained workers on short notice or for short periods of time.

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