1. To combat recession and depression, which should have priority: unemployment or debt reduction? Justify your...

1. To combat recession and depression, which should have priority: unemployment or debt reduction? Justify your opinion with a good explanation.

Expert Solution

The choice between reduction in unmployment and reduction in the amount of accumulated debt depends on the status of fiscal deficit. If the nation is running a high fiscal deficit such that debt GDP ratio is very high, it is usually believed that the nation should more focus on reducing the debt.

This however, is not a correct approach. Rising unmployment implies idle resources and increasing unmployment insurance. There are nations that have persistant unemployment of more than 10 percent and are experiencing a sluggish growth. Once such a nation is hit by a recession, it becomes very difficult to raise employment or even reducing debt. Some scholars have used the term twin deficits in this case where debt as well as unemployment both are higher.

Allowing unemployment to increase and reducing spending and increasing taxes to control the debt, will ultimately increase the output gap and will increase the intensity of recession. In contrast, even if there is 100 percent debt GDP ratio, the priority is to reduce unmployment first, as fiscal contraction also increases debt as there is an increase in mandatory spending when there is higher unemployment. Fiscal contractions during recessions are strictly avoided as they can result in a deep recession.

Rahul Sunny answered 1 year ago

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