Fiscal policy can decrease unemployment by helping to increase AD. By cutting taxes and increasing government spending. Lower taxes increase disposable income and therefore help to increase consumption. With an increase in AD, there will be an increase in Real GDP (as long as their is spare capacity in the economy.) IF there is an increase in GDP there will be an increase in demand for workers and therefore lower demand deficient unemployment. However,
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. 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 increase in AD will only cause inflation. Monetary Policy
Monetary policy would involve cutting interest rates. Lower rates decrease the cost of borrowing and encourage people to spend and invest. This increases AD and should also help to increase GDP and reduce demand deficient unemployment. Also lower interest rates will reduce exchange rate and make exports more competitive. However, Demand side policies can help to reduce demand deficient unemployment e.g. in a recession. However, they cannot reduce supply side unemployment. Therefore, there effectiveness depends on the type of unemployment that occurs.
Supply-side economists (Gov.) to reduce unemployment.
1. Better job information to help reduce frictional unemployment. 2. Lower unemployment benefits to increase the incentive to get a job. It is argued generous unemployment benefits create an unemployment trap, where those on benefits would not get any extra income after tax if they decided to work. 3. Increase Labour market flexibility( easier to hire and fire workers) 4. Reduced Power of Trades Unions. Trades unions can cause real wage / classical unemployment. If you reduce...
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