U.S. Economy

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.

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.

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