The Role of Aggregate Demand in Reducing unemployment

Evaluate the importance of managing aggregate demand to bring about a sustained reduction in the rate of unemployment in the UK economy.

In 1992 Unemployment in the UK rose to 3 million, a lot of this was due to the recession of 1992.

In a recession, demand deficient unemployment will increase. This is because as firms close down they have to lay off workers. Therefore, in this case, it is important for the government to try and boost AD and increase the rate of economic growth. For example, the government could pursue expansionary fiscal policy; e.g - lower taxes and higher government spending. This will lead to an increase in AD and therefore, higher growth and jobs will be created reducing unemployment.

If AD increases too quickly it will cause inflation. Therefore, the growth may be unsustainable and the boom may lead to a bust. In this case the job creation will only be temporary. Therefore, it is important to manage AD, so as to maintain stable, low inflationary growth. This will allow a sustained reduction in unemployment. To a large extent, this is what has happened in the UK since 1992. The MPC has used monetary to enable low inflation and stable growth.

Therefore AD is very important. However, there are many other types of unemployment which will not be reduced through demand management.

These include:

• frictional unemployment (looking between jobs)
• Structural unemployment. - People without the right skills for the labour market
• Geographical unemployment - mismatch of skills throughout the country.
• Real wage unemployment - caused by wages being above equilibrium levels.
• disguised unemployment - when people are put onto sickness benefits. (not counted in official JSA measure) See true level of unemployment in the UK
• Voluntary unemployment - when benefits are too high they encourage people to remain on benefits rather than work.

E.g. It is argued that if the EU experienced faster growth, unemployment will still remain a problem because of structural supply side factors. Often know as the natural of unemployment.

To achieve full employment it is necessary to use supply side policies as well.

Related Essays:

• Natural Rate of Unemployment 
• The effect of Domestic demand on an economy