Question

discuss the types of monetary and fiscal policies that could be introduced to reduce unemployment

Answer 1

Monetary Policy

The central bank can pursue Expansionary Monetary Policy to reduce the rate of unemployment. Expansionary monetary policy includes the following action -

1. Open market purchase of bonds

2. Lowering the discount rates

3. Lowering reserves requirement

To elaborate, when the fed purchases bonds from the open market, banks get cash infusion in exchange for bonds. This increases the money supply in the banking system. As money supply increases, the cost of money ( interest rates) decline. This translates into relatively higher consumption spending in the economy. Further, as consumption spending is boosted, investment spending also increases and this results in job creation. Therefore the objective is to lower cost of debt to trigger leveraged consumption and investment spending. Similarly, the fed can lower the discount rate, which is the rate at which the banks borrow short term liquidity from the fed. This also increases the money supply and has the same effect. A lesser used tool is lowering of reserve requirement of banks as the first two tools are more effective.

Similarly,

Expansionary fiscal policy includes the following -

1. Lower tax rate
2. Higher government spending

When tax rate is lowered, consumer disposable income rises and it triggers higher consumption spending. Higher consumption spending translates into higher investment spending and job creation. When government spending increases on social security and infrastructure projects, among others, it supports lower income consumption spending and job creation through investment in infrastructure.