Question

During period of decline in economic activities (recessions) where unemployment rates are above the normal rates (more layoffs), would you consider a government’s decision to reduce interest rates a viable solution to stimulate the economy to employ more factors of production (capital and people)? Is it possible (or beneficial) to keep the interest rates low for a long period of time? Explain the mechanism in which lower or higher interest rates lead to lower unemployment

Justify your answer for both the short-run and the long-run, keeping in mind the effect of inflation rates on such decision.

Answer 1

Recession is a business cycle contraction when there is a general decline in economic activity in the economy. It  generally occurs when there is a widespread drop in spending. In fact, recession is the result of some economic events like financial crisis, adverse supply shock etc.In such cituation , all the economic activities will be stagnant There will not be any kind of economic development or economic activities. Economic activities are the activities which contribute to gross national product.

In times of recession, unemployment will be t its peak. Unemployment is situation in which people who are willing to work t the existing wage rate can not find job. This in turn, will led to loss of potential employment. in such situations, Government will cut short the interest rte.Growth increase leads to unemployment decrease which further leads to inflation. Increase which call for an increase in interest rate and it slows down the growth which then increase unemployment. When unemployment is high, the number of people looking for work exceeds the the number of jobs available in the market. Or we can say the supply of labor is greater than the demand for labor and there by again leads to little need for employees lead to wages to remain stagnant or no wage inflation.

Still, Lower interest rates make it cheaper to borrow, resulting in increased spending and investment.