Question

Chapter 14 discusses various government 'policy levers' that past and current presidents have used to bring about some desired economic result (help unemployment, reduce inflation, etc.). Discuss one or more that you feel were effective or interesting?

Answer 1

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Various government 'policy levers' that past and current presidents have used to bring about some desired economic result (help unemployment, reduce inflation, etc.). Discuss one or more that you feel were effective or interesting

A) Unemployment

The unemployment rate is a vital measure of economic performance. A falling unemployment rate generally occurs alongside rising gross domestic product (GDP), higher wages, and higher industrial production. The government can generally achieve a lower unemployment rate using expansionary fiscal or monetary policy, so it might be assumed that policymakers would consistently target a lower unemployment rate using these policies. Part of the reason policymakers do not revolves around the relationship between the unemployment rate and the inflation rate.

Two other sources of variation in the rate of inflation are inflation expectations and unexpected changes in the supply of goods and services. Inflation expectations play a significant role in the actual level of inflation, because individuals incorporate their inflation expectations when making price-setting decisions or when bargaining for wages. A change in the availability of goods and services used as inputs in the production process (e.g., oil) generally impacts the final price of goods and services in the economy, and therefore changing the rate of inflation.

The natural rate of unemployment is not immutable and fluctuates alongside changes within the economy. For example, the natural rate of unemployment is affected by changes in the demographics, educational attainment, and work experience of the labor force,institutions (e.g., apprenticeship programs) and public policies (e.g., unemployment insurance); changes in productivity growth and contemporaneous and previous level of long-term unemployment

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)

A quick list of policies to reduce unemployment

1. Monetary policy – cutting interest rates to boost aggregate demand (AD)
2. Fiscal policy – cutting taxes to boost AD.
3. Education and training to help reduce structural unemployment.
4. Geographical subsidies to encourage firms to invest in depressed areas.
5. Lower minimum wage to reduce real wage unemployment.
6. More flexible labour markets, to make it easier to hire and fire workers.

B) Reduce inflation

• Governments can use wage and price controls to fight inflation, but that can cause recession and job losses.
• Governments can also employ a contraction monetary policy to fight inflation by reducing the money supply within an economy via decreased bond prices and increased interest rates.

Below is the summary of policies to reduce inflation

• Monetary policy – Higher interest rates. This increases the cost of borrowing and discourages spending. This leads to lower economic growth and lower inflation.
• Tight fiscal policy – Higher income tax and/or lower government spending, will reduce aggregate demand, leading to lower growth and less demand-pull inflation
• Supply-side policies – These aim to increase long-term competitiveness, e.g. privatization and deregulation may help reduce costs of business, leading to lower inflation.

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