Question

  As businesses reopen after the shut down response to the Covid virus, the unemployment rate is exceptionally high and the economy is likely producing far below its potential. Identify a policy that may help lift the economy out of this slump. Present an graph analysis where you explain the impact you expect from your policy on output, prices, wages, employment, and unemployment

Answer 1

Unemployment rate is at its high, economy is producing less than full potential level of economy which means there exist a recessionary gap in the economy. Government have to raise aggregate demand in the economy to avoid recession.

The best policy which can raise aggregate demand is expansionary fiscal policy through which government raise their spending and reduce taxes such that people have more disposable income and have more money to spend on goods and services which raise aggregate demand in the economy.

In addition to this, Fed can adopt expansionary monetary policy which inject money in the economy and give more money in the hands of public to spend on goods and services which raise the aggregate demand in the economy.

Both of these factors will partially remove the recessionary gap and may take it to the full potential level in the economy. It will cause price of goods to rise, unemployment to fall, output to rise and nominal wage to rise but real wage may rise or fall.