Question

The number of jobs available in the U.S. economy is largely determined by the number of workers private firms choose to hire. In 2016, firms employed 124 million people. The Federal Reserve is part of the federal government and hires relatively few people, about 22,000 in 2016. Even if the Fed doubled or tripled its work force, it would have little impact on employment levels, yet economists strongly link actions of the Fed to the level of total employment in the economy. Carefully explain how the Fed is able to affect the level of total employment in the economy. Be sure to include all relevant actions the Fed can take in affecting total employment.

Answer 1

The Federal Reserve is in charge of the monetary policy in the United States. It expands or reduces the money supply (the total amount of money in the economy) by raising or lowering the interest rate.

There is a relationship, in the short run, between unemployment and money supply. The higher the money supply, the lower the unemployment rate, and viceversa: the lower the money supply, the higher the unemployment rate.

This relationship exists because when the money supply increases, the interest rate falls, if the interest rate falls, investing becomes cheaper, and as a result, firms invest more and hire more workers.

The opposite happens when the money supply is contracted: interest rates rise, investing becomes more expensive, and firms hire less people.

This is why the Fed has a great deal of power when it comes to employment in the economy.