Bank to the government. That new money is put into the economy as soon as the government spends the funds. On the other hand, if the Federal
Reserve sells government bonds, it collects money that is taken out of circulation, since the bonds that the Federal Reserve sells to banks, firms, or households cannot be used as money until they are redeemed at a later date.
The Wall Street Journal and other financial media regularly report on
purchases of bonds made by the Federal Reserve and other buyers at
auctions of U.S. government bonds. The Federal Reserve System itself also
publishes a record of its buying and selling in the bond market. In
practice, since the U.S. economy is growing and the money supply must
grow with it to keep prices stable, the Federal Reserve is almost always
buying bonds, not selling them. What changes over time is how fast the
Federal Reserve wants the money supply to grow, and how many dollars
worth of bonds it purchases from month to month.
To summarize the Federal Reserve System’s tools of monetary policy: It
can increase the supply of money and the availability of credit by
lowering the percentage of deposits that banks must hold as reserves at
the Federal Reserve System, by lowering the discount rate, or by
purchasing government bonds through open market operations. The Federal
Reserve System can decrease the supply of money and the availability of
credit by raising reserve ratios, raising the discount rate, or by
selling government bonds.
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.
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