Question

If the natural rate of unemployment is at 5% and current unemployment is at 2% what fiscal policy(s) would be used? Why?

Answer 1

Contractionary fiscal policy

The unemployment rate is less than the natural rate of unemployment means the economy is in the inflationary gap where resources are used above the potential level, and the actual output is above the potential level of output. To reduce an inflationary gap, contractionary policy is used.

Contractionary policy is to decrease government spending or increase taxes to reduce AD and shifts it to the left which decreases actual output to potential output level and decreases price level.