Reducing Unemployment By Using Monetary Policy

Readers Question: how to solve unemployment by tools of monetary policy?

Monetary policy effectively means changing interest rates to influence aggregate demand, economic growth and therefore demand for workers.

The UK is heading into recession and unemployment is rising. It is argued a cut in interest rates would help reduce unemployment.

• Lower interest rates reduce the cost of borrowing encouraging spending and investment.
• Lower interest rates reduce the cost of mortgage payments giving homeowners more disposable income and therefore spending increases.
• Therefore, lower interest rates should help increase consumer spending and investment. Therefore, aggregate demand will rise. If there is spare capacity in the economy, there will be an increase in economic growth and therefore firms will demand more workers. This will help reduce demand deficient unemployment.

However:

• Lower interest rates may not increase consumer spending if confidence is very low. (e.g. in a recession, people may not want to borrow to invest, even if interest rates are very low)
• Cutting interest rates will only solve demand deficient unemployment. It will not reduce supply side unemployment – the natural rate

• The role of AD in reducing unemployment
• Discuss whether demand side policies reduce unemployment