Tight labor markets are
essential to reducing racialdisparities and within thepurview of the Fed’s dual
mandateBlog • By Valerie Wilson • May 10, 2024

• Washington, DCView this blog at epi.org/283299

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This essay was originally published in the Point/Counterpoint section of the Journal ofPolicy Analysis and Management and can be accessed at https://doi.org/10.1002/pam.22545.

Key findings•Growing evidence shows that monetary policy decisions have a measurable
impact on racial disparities in the labor market. This evidence challenges longheld beliefs about the purview of the Federal Reserve (“the Fed”)’s mandate
and the limits of macroeconomic policy. These findings deserve serious
consideration as the Fed begins review of its monetary policy framework.

•

Monetary policy decisions can help sustain tight labor markets, which cansignificantly reduce the Black unemployment rate and narrow the Black-whiteunemployment rate gap.

•In addition, tight labor markets have great potential to reduce racial wage
inequality by boosting bargaining power and supporting faster wage growthfor Black and low-wage workers.

•In recent years, tight labor markets have facilitated greater racial equity andincreased economic security for Black Americans without triggering acorresponding spike in inflation.

How to fix it
Proposals to make racial equity a more explicit consideration of the Fed include
having Congress require the Fed chair to report on racial gaps in employment
and wages, and the actions being taken to reduce them. The Fed can also
center equity by engaging in research on the causes of the racial gaps.

Racial disparities in unemployment are a defining feature of the U.S. labor market. Since
the U.S. Bureau of Labor Statistics (BLS) began reporting a Black unemployment rate in1972, it has consistently been about double the white unemployment rate. On average,
since unemployment rates decline with increasing levels of education, racial disparities inunemployment have commonly been attributed to observed racial differences in
educational attainment or skills. However, the persistent 2-to-1 Black-white unemployment
ratio is largely unexplained by observable factors like education or skills. In fact, the 2-to-1
ratio between Black and white unemployment rates exists at each level of education,1

across age cohorts, and for men and women, suggesting that broader structural factors,including racial discrimination and unequal bargaining power, lie at the root of persistentinequality in labor market outcomes between Black and white Americans.
The persistence of the Black-white disparity in unemployment makes it an ideal target for
equity-focused policymaking. However, the idea that the unemployment rate gap is largely
the result of a Black-white human capital gap has dominated decisions about theappropriate policy levers for closing the gap. As a result, most interventions focus onindividual acquisition of additional skills or education rather than removing structuralbarriers to more equitable outcomes. This human capital-centered approach also
undergirds the long-standing view that narrowing racial disparities in unemployment is
outside the purview of the Federal Reserve (“the Fed”)’s legal mandate to maximize
employment while maintaining price stability.
Adjusting short-term interest rates is the primary tool the Fed uses to manage this dualmandate. When the Fed lowers interest rates, it increases economywide spending andaggregate demand. This in turn raises employment (and lowers unemployment) as firms
hire more workers to meet growing demand. As demand and employment continue torise, so can the risk of inflation, motivating the Fed to raise interest rates to dampen
demand. As demand falls, employment falls (and unemployment rises).
While the Fed’s monetary policy tools are not sufficient to fully address all of the structural
factors at the root of the Black-white unemployment rate gap, the consistency of the 2-to-1
Black-white unemployment ratio means monetary policy decisions have predictable
implications for the level of unemployment experienced by Black Americans and white
Americans. There is also growing evidence that monetary policy decisions that sustain
tight or high-pressure labor markets can significantly reduce the Black-whiteunemployment rate gap.
Figure 1 presents the Black-white unemployment rate ratio (measured along the right yaxis) and the difference between the Black and white unemployment rates (measuredalong the left y-axis) between 1972 and 2023. Historically, the Black-white unemployment
ratio has changed very little with fluctuations in the business cycle. However, the ratio has
gradually trended downward in recent years, more often falling just under 2 to 1 since
2018, compared with previous decades when the ratio was more often at or above 2 to 1.
The most notable changes in the gap are measured by the percentage point difference
between the Black and white unemployment rates, which narrows considerably in tighterlabor markets.

Slack labor markets sustain needlessly high Black
unemployment
In recent decades, genuinely tight labor markets have been rare, consigning Black
Americans to chronically high unemployment. Given this relationship, centering equity
would require that the Fed prioritize, or at least give considerable weight to, maximizing
employment when setting the nation’s monetary policy. Yet genuinely tight labor markets
have been rare for most of the last 5 decades. Between 1972 and 2019, the actual2

Monthly Black-white unemployment rate ratio andBlack-white percentage point difference in employment
rates, 1972–2023
153

102
Ratio

Percentage-point difference

Figure 1501

1970

1980

1990

2000

Black-white percentage point difference

201020200Black-white ratio

Sources: Author analysis of U.S. Bureau of Labor Statistics Current Population Survey, Monthly
Unemployed Rate by Race and Ethnicity data series LNS14000003 and LNS14000006, retrieved fromFRED.

unemployment rate averaged 6.2%, which is 0.7 percentage points higher than theaverage Congressional Budget Office estimates of the natural rate of unemployment(5.5%) over that period. The natural rate of unemployment is also referred to as the nonaccelerating inflation rate of unemployment (NAIRU)—a conservative approximation of thelowest level of unemployment that can be sustained while maintaining price stability.
By this standard, the Fed has arguably erred on the side of allowing more labor market
slack to keep inflationary pressures down. This has not only resulted in higher thannecessary national rates of unemployment but has needlessly consigned Black workers tomuch higher rates of unemployment. For example, when Chair Paul Volcker aggressively
sought to reduce inflation between 1980 and 1983, the national unemployment rate roseto over 10% while the Black unemployment rate peaked at over 20%, as shown in Figure
2. By contrast, the highest monthly white unemployment rate during that time was 9.7%
according to the Current Population Survey.
Between 1972 and 2019, the Black unemployment rate had never fallen below 6% until abrief 6 months in 2019, just months before the pandemic-triggered recession in the firsthalf of 2020. In the subsequent economic recovery, the Black unemployment rate dipped
below 6% again in April 2022, and has averaged 5.7% between April 2022 and July 2023.
Since 2019, the Black-white unemployment rate gap (percentage point difference between
Black and white unemployment rates) has also reached historic lows (See Figure 2).

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Figure 2

National, Black, and white (monthly) unemployment rates,
1972–2023
30

20

100

1970

1980

1990
Black

2000
National

2010

2020

White

Source: U.S. Bureau of Labor Statistics Current Population Survey, Monthly Unemployed Rate by Race andEthnicity data series LNS14000000, LNS14000003 and LNS14000006, retrieved from FRED.

The historic result of the Fed’s response to the GreatRecession
The Fed’s extraordinary and unprecedented measures in response to the Great Recession
tested the limits of monetary policy, yielding the historically low rates of Black
unemployment and the accompanying record-low Black-white unemployment rate gap. As
shown in Figure 3, for nearly seven consecutive years, between January 2009 andDecember 2015, the Federal Open Market Committee (FOMC) maintained a near-zerofederal funds effective rate (below 0.25%). Rates remained under 2.5% through October
2022—registering almost 14 consecutive years of interest rates at or below thatlevel—when the FOMC began enacting more aggressive interest rate hikes in an effort tobring down stubbornly high rates of inflation related to the pandemic. This marked
change—from a Federal Reserve that tolerated more labor market slack to one that waswilling to push the limits of maximum unemployment by targeting a near-zero federal
funds rate for several years following the Great Recession—reduced the Black-whiteunemployment rate gap to an annual average of less than 3 percentage points in 2019 forthe first time on record.

Tight labor markets and the reduction of Black-white labormarket disparities
Research confirms the benefits of tight labor markets for reducing Black-white labor4

Figure 3

Federal funds effective rate, 1955–2023
2010019601980

20002020

Federal funds effective rate
Source: Board of Governors of the Federal Reserve System (US), Federal Funds Effective Rate
[FEDFUNDS], retrieved from FRED.

market disparities. Empirical studies examining the relationship between tight labormarkets and Black-white unemployment rate gaps support these observations. One study
demonstrated that the primary mechanism for this narrowing of the Black-whiteunemployment rate gap is indeed a greater responsiveness of Black unemployment tomacroeconomic forces. In other words, when the national (or white) unemployment ratechanges by 1 percentage point, the Black unemployment rate changes by more than 1
percentage point. Utilizing data for 1975 to 2018, the authors found evidence suggestingthat as strong labor markets tighten further, the improvements in racial disparities get
incrementally greater. Moreover, as the unemployment rate moved below theCongressional Budget Office’s natural rate, the unemployment rates of the mostmarginalized groups experienced the greatest improvements. For example,
unemployment rates of young Black Americans, ages 16 to 24, were more responsive tofurther labor market tightening than those of young white Americans and older Black
Americans (ages 25 to 64). Unemployment rates of young Black Americans are
consistently at least twice as high as those of young white Americans and older BlackAmericans.
Another study concluded that as the labor market recovery from the Great Recession
continued to move forward (2016 was the latest data year in this analysis), the recovery
contributed substantially to reducing the unemployment gaps that had widened
dramatically during the Great Recession. Additionally, the authors found that the relatively
higher risk of job loss among Black Americans compared with white Americans was thebiggest driver of racial unemployment gaps and the differential cyclicality ofunemployment. Based on this finding, an extended period of labor market tightness isactually essential to the recovery of job losses among Black Americans as well as reducing

5the Black-white unemployment rate gap. The authors also found evidence that among
women, the portion of the Black-white gap unexplained by observable factors declined
from more than 6 percentage points in 1976 to about 3 percentage points in 2016, withmost of the decline occurring in the very tight labor markets of the 1990s. Given theauthors’ related finding that the majority of the Black-white unemployment gap isunexplained by observable factors, one might interpret this result as an indication thattight labor markets can effectively limit the extent of racial labor market discrimination—astructural barrier to employment—experienced by Black women.
In addition to reducing racial disparities in unemployment, tight or high-pressure labormarkets also support faster wage growth for Black and low-wage workers . Tight labormarkets help to boost the bargaining power of the most marginalized workers because atlower rates of unemployment, employers face greater competition for workers. This gives
workers increased leverage to either move to a higher paying job or negotiate for higher
wages in their current job. As a result, high-pressure labor markets also hold great
potential to reduce racial wage inequality.
Another author presented counterfactual trends in the Black-white wage gap for 1973 to
2019 under less contractionary monetary scenarios than those that prevailed using theestimated coefficients on the responsiveness of the median hourly wages of Black andwhite workers to the unemployment rate. Specifically, if unemployment had averaged 2
percentage points less between 1973 and 2019, 80% of the median Black-white wage gap
that appeared in 1973 could have been erased (shrinking from 28.6% to 5.4%). With
unemployment averaging just 1 percentage point less, the median wage gap could havefallen slightly (to 18.0%) rather than rising by almost 8 percentage points over this period.
The gap-narrowing power of high-pressure labor markets is amplified even more whenlooking at median annual earnings, which are affected through higher hourly wages aswell as increased hours worked during the year. The same study reported that if theunemployment rate had averaged 1 to 2 percentage points lower after 1973, the Blackwhite annual earnings ratio would be over 90% or essentially 1, respectively. It’s importantto recognize that the benefits of increased annual earnings extend beyond the individualworker, contributing to higher household income and reduced poverty for both the worker
and their dependents.
Evidence of the immense potential for tight labor markets to facilitate greater racial equity
and increased economic security for Black Americans is compelling. Still, it is important toacknowledge that tight labor markets can pose a risk to price stability. Here, as well, therecord suggests that these risks are no longer as high as perhaps they may have been inthe past. Though inflation has been unacceptably and stubbornly high during the recent
period of post-pandemic labor market tightening, the Fed has not attributed this to an
overheated labor market. Rather, in public statements, the FOMC acknowledges that mostof the spike in inflation was caused by supply and demand imbalances related to thepandemic (namely shift in consumer demand for durable goods and supply chainbottlenecks) with added pressures from the war in Ukraine and COVID-19-related
shutdowns in China. Additionally, inflation was consistently below the Fed’s target for mostof the six years preceding the pandemic, and remained stable even as the unemployment

6rate fell below estimates of the NAIRU, consistent with an apparent flattening of thePhillips curve. When unemployment declined to about 4% in the late 1990s, and evenbelow 4% in 2018 to 2019, there was no marked uptick in wage or price inflation requiring
the Fed to slow demand growth.

Recommendations for how the Fed can actively center
equityTogether, these outcomes suggest more room for flexibility in the Fed’s policymaking
targets and goals, a point that has not gone unnoticed by Federal Reserve leadership.
Janet Yellen, the previous Federal Reserve Board chair, led a shift to a more datadependent Fed, signaling a more statistics-driven wait-and-see approach tomacroeconomic policymaking over fixed targets and predictions. Arguably, this shiftcontributed to decisions to keep interest rates near 0% for almost seven years. It also laid
the groundwork for the Fed’s new monetary policy framework, introduced in August 2020
by the current Federal Reserve Board Chair, Jerome Powell. Under the new framework,
maximum employment is “a broad-based and inclusive goal that is not directly measurable
and changes over time.” While this framework falls short of explicitly centering equity as agoal, it allows for greater flexibility in assessing maximum employment using a wide rangeof indicators rather than specifying a fixed target.
Powell’s statements before Congress have gone further in acknowledging the significanceof Federal Reserve decisions for specific racial and ethnic groups, different communities
across the country, and low-wage workers rather than the overall macro economy. But
there is room for the Fed to go further in establishing a path to greater racial equity in thelabor market. The potential to close racial disparities in the labor market should beconsidered a substantial benefit in FOMC deliberations when weighed against the risk ofinflation. Moreover, testing the limits of maximum sustainable employment provides
policymakers at the Fed and in Congress with better information about what else should
be done to close persistent racial gaps. When unemployment is low, presumably those
who remain unemployed are either in transition between one labor force status to another(i.e., entering the labor market or between jobs) or face specific barriers to employmentthat need to be addressed through more targeted interventions.
Some have recommended a path to making equity a more explicit consideration byproposing that Congress require the Fed chair to report on racial employment and wagegaps, as well as what the Fed is doing to reduce them, in their spoken and written
testimony. Other suggestions include that the Fed make use of other tools in addition tointerest rate policy to establish and center equity goals. These tools consist of engaging inresearch on the causes of the racial gaps, as well as tracking economic stability among
vulnerable families and access to affordable capital, including housing, in disinvested
communities.

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