Key Labor Economics and Monetary Policy Concepts

Labor Market Metrics and Definitions

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• Labor-Force Participation Rate: (Employed + Unemployed (Labor Force)) / Adult Population.
• Unemployment Rate: (Unemployed) / (Labor Force).
• Employment Rate: (Employed) / (Adult Population).

Types of Unemployment

1. Frictional: Temporary unemployment arising during the job search process (voluntary).
2. Structural: Unemployment caused by restructuring of the economy or institutions. This includes sectoral shifts (changes in industrial structure) (involuntary).
3. Cyclical: Unemployment related to the business cycle (economic fluctuations). This rate is zero at full employment.

Why the Unemployment Rate Underestimates Unemployment Status

The unemployment rate does not fully capture the status because it excludes discouraged workers and those actively seeking work but classified as non-labor force participants. Examining the employment rate alongside it provides a more accurate assessment.

Natural Rate of Unemployment

The term was first used by M. Friedman. It is defined as:

1. The long-run equilibrium rate of unemployment.
2. The unemployment rate corresponding to potential GDP.
3. The full-employment unemployment rate.
4. The non-accelerating inflation rate of unemployment (NAIRU).

Labor Market Institutions

• Unemployment Insurance: Payments made to the unemployed, typically 50% of previous wages, which may discourage job-seeking efforts.
• Minimum Wage Law.
• Labor Union: Addresses worker concerns and acts as an antidote to the market power of firms, leading to more efficient firm responses.
• Collective Bargaining.
• Efficiency Wage: Wages paid above the market-clearing level to achieve specific benefits:
  1. Worker health $\uparrow$
  2. Worker turnover $\downarrow$
  3. Worker quality $\uparrow$
  4. Worker effort $\uparrow$

Monetary Economics and Central Banking

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Money Fundamentals

Money: The set of assets generally accepted in trade for goods and services.

Functions of Money

1. Medium of Exchange
2. Unit of Account
3. Store of Value

Barter Economy Issues: Requires time and effort, and relies on the double coincidence of wants, leading to high transaction costs.

Types include Commodity Money and Fiat Money (which has no intrinsic value).

Gold Standard: Involves using gold as money, where paper money is convertible to gold at a fixed rate on demand (a mechanism for price stability).

Money Supply Measures and Liquidity

• M1 = Currency + Demand Deposits.
• M2 = M1 + Savings Deposits.
• Liquidity: The ease with which an asset can be converted into cash without loss in value. Liquidity ranking: Currency > Stocks > Bonds > Real Estate > Antiques.

The Central Bank (The Fed)

Roles: (Micro) Supervises the banking and financial system; (Macro) Controls the money supply.

Tools of Monetary Control

1. Open Market Operations
2. Fed lending to banks
3. Reserve requirements
4. Paying interest on reserves
5. Discount Rate

Federal Funds Rate: The interest rate at which banks make overnight loans to one another.

Main Jobs of the Federal Reserve:

1. Regulate banks to ensure the health of the banking system.
2. Control the quantity of money in the economy.

To Expand Money Supply, the Fed can:

1. Loan more to banks by lowering the discount rate.
2. Lower reserve requirements.
3. Decrease interest paid on reserves.

Board of Governors: Consists of seven members, appointed by the President for 14-year terms.

Banking Structure and Regulation

• Bank Capital: The resources owners have put into the institution.
• Leverage: Using borrowed money to supplement existing funds for investment.
• Leverage Ratio: The ratio of assets to bank capital (Debt / Total Assets). A high ratio indicates more aggressive lending.
• Discount Rate: The interest rate on loans the Fed makes to banks.
• Reserve Requirements: Regulations setting the minimum amount of reserves banks must hold against deposits.
• Bank Run: A situation where many depositors attempt to withdraw funds simultaneously. This is less of a major problem today due to guarantees, primarily through the Federal Deposit Insurance Corporation (FDIC).

Monetary Policy Adjustments

Exit Strategy: A plan to reverse expansionary monetary policy (which increased money supply during a recession) when the economy improves, to prevent inflation.

QE (Quantitative Easing): A method of increasing the money supply when interest rates are already near zero.

Key Relationship: Buying bonds $\rightarrow$ Money supply $\uparrow \rightarrow$ Fed funds rate $\downarrow$.