Question

9.Pretend GDP is too low (which means there is high unemployment). Explain what the Government

(fiscal policy) and/or the Federal Reserve (monetary policy) would do to solve this problem. (Be

specific, and spell it out clearly...) (6 sentences min)

Answer 1

In case of Low GDP, the government Fiscal policy and Federal Reserve could take certain steps to increase the employment in the economy.

Fiscal Policy: Fiscal policy is the mean by which the government adjust is expenditure and taxes to stimulate the growth and demand in the economy. Certain steps that the government can take in situation of unemployment are,

• Introducing a fiscal deficit: A fiscal deficit is a situation when the government expenditure is more than the government income from all sources. If the government runs fiscal deficit i.e. high expenditure the demand in the economy rises. The firms in the economy produce more to meet that extra demand and hire more labor (labor is the variable factor in the production which can change in the short run.) This will reduce the unemployment.
• Reducing taxes: Government can reduce the taxes the companies pay to operate in the economy. This will increase the incentive to expand the production and the cut in taxes can be passed onto the consumer making things cheaper for them. Increased demand will again increase production and reduce unemployment in the economy.

Monetary policy: Monetary policy is managing the money supply and interest rates in the economy to stimulate demand and economic growth.

Easy monetary policy: The fed can buy bonds and increase the liquidity in the market or they can just decrease the interest rates on loans. Increasing the money supply in the economy will put extra money in hands of people and they will demand more good. Firms will produce more and hire more labor to decrease the unemployment.

Decreasing the interest rates will improve the marginal efficiency of capital and make expansion more lucrative. Business will invest more and this will create extra demand again decreasing the unemployment rate.

Conclusion: In case of increased unemployment both the fiscal policy and the monetary should focus on increasing the demand in the economy. The government can reduce tax and increase expenditure and Fed can use easy money policies to the same effect. This will reduce the unemployment in the economy.