Question

7) Explain the relationship between the business cycle, unemployment, inflation and monetary and fiscal policy.

Answer 1

The business cycle consists of four components as expansion, peak, trough and contraction. The real variables like inflation, unemployment and GDP gets affected by the variations or fluctuations in the business cycle which may or may not occur at regular basis.

During expansion, GDP grows rapidly, unemployment is low and inflation is at its target limits while with time the economy gets overheated and expansion transits into contraction with contrary impact on variables like inflation rises unemployment declines etc. While the highest point of expansion is the peak and the bottom of the economy is trough.

There are fiscal and monetary policies which manage the business cycle and its impact on the economy. For example, a contraction or trough can be stimulated by using an expansionary fiscal policy also central bank uses monetary policy for suppose the economy is overheated, it can lower rate of interest to ease out funds.