There are two main strategies for reducing unemployment -
• Demand side policies to reduce demand-deficient unemployment (unemployment caused by recession) • Supply side policies to reduce structural unemployment / (the natural rate of unemployment) Demand Side Policies
Demand side policies are important when there is a recession and rise in cyclical unemployment. (e.g. after 1991 recession and after 2008 recession)
1. Fiscal Policy
Fiscal policy can decrease unemployment by helping to increase aggregate demand and the rate of economic growth. The government will need to pursue expansionary fiscal policy; this involves cutting taxes and increasing government spending. Lower taxes increase disposable income (e.g. VAT cut to 15% in 2008) and therefore help to increase consumption, leading to higher aggregate demand (AD).
With an increase in AD, there will be an increase in Real GDP (as long as there is spare capacity in the economy.) If firms produce more, there will be an increase in demand for workers and therefore lower demand-deficient unemployment. Also, with higher aggregate demand and strong economic growth, fewer firms will go bankrupt meaning fewer job losses.
Keynes was a strong advocate of expansionary fiscal policy during a prolonged recession. He argue that in a recession, resources (both capital and labour) are idle, therefore the government should intervene and create additional demand to reduce unemployment.
Impact of Higher AD on Economy
1. It depends on other components of AD. e.g. if confidence is low, cutting taxes may not increase consumer spending because people prefer to save. Also, people may not spend tax cuts, if they will soon be reversed. 2. Fiscal policy may have time lags. E.g. a decision to increase government spending may take a long time to have an effect on increasing AD. 3. If the economy is close to full capacity an...