Fiscal and Monetary Policy for Reducing Unemployment

can u tell me critically discuss the possible ways including their implications and limitations to decrease the rate of unemployment in short run and long run including fiscal and monetary policies

Fiscal policy can decrease unemployment by helping to increase AD.

This involves cutting taxes and increasing government spending.  Lower taxes increase disposable income and therefore help to increase consumption. With an increase in AD, there will be an increase in Real GDP (as long as their is spare capacity in the economy.) IF there is an increase in GDP there will be an increase in demand for workers and therefore lower demand deficient unemployment.

However,

1. It depends on other components of AD. e.g. if Confidence is low, cutting taxes may not increase consumer spending because people prefer to save.
2. Fiscal policy may have time lags. E.g. a decision to increase government spending may take a long time to have an effect on increasing AD.
3. If the economy is close to full capacity an increase in AD will only cause inflation.
4. In the long run expansionary fiscal policy may cause crowding out. i.e. the government increase spending but have to borrow from private sector, therefore, the private sector have less to spend and therefore AD doesn’t increase. (this is the Monetarist view)

Monetary Policy

Monetary policy would involve cutting interest rates. Lower rates decrease the cost of borrowing and encourage people to spend and invest. This increases AD and should also help to increase GDP and reduce demand deficient unemployment.

Also lower interest rates will reduce exchange rate and make exports more competitive.

Evaluation

• Similar problems as fiscal policy. e.g. it depends on other components of AD.
• It will do nothing to solve supply side unemployment
• Demand side policies can help to reduce demand deficient unemployment e.g. in a recession. However, they cannot reduce supply side unemployment. Therefore, there effectiveness depends on the type of unemployment that occurs.