Question

You have been called by the president to advise him on what should be done to increase employment, increase growth, keep interest rates about the same and lower inflation.  Armed with your knowledge of the Keynesian and classical models, what would be your advice and why? Make sure you use economic analysis to arrive at your conclusions.

Answer 1

The aim of the policymaker is to increase employment, increase growth, keep interest rates about the same and lower inflation. An appropriate policy mix would be to use expansionary fiscal and monetary policy

Expansionary fiscal policy will raise government spending or reduce taxes. This will raise interest rates, price levels, real output and employment when aggregate demand is shifted to the right in AS-AD model. To combat rising interest rate and inflation, monetary expansion can hit one of these targets which is interest rate.

Higher money supply increases liquidity and this reduces the rate of interest. Inflation is however the cost that has to be borne becasue all policy targets cannot be achived. There is a short run tradeoff between inflation and unemployment. Hence one of the targets would not be achieved but the economy will be stabilized.