Question

If the government implements a contractionary fiscal policy measure, but keeps monetary policy inactive, according to the short run Phillips Curve:

a. actual inflation will decline and unemployment will decline as well

b. actual inflation will increase and unemployment will decrease

c. actual inflation will decline and unemployment will increase

d. expected inflation will decline and unemployment will decline as well

Answer 1

Contractionary Fiscal Policy reduces the amount of government spending on public infrastructure. This will shift the Aggregate Demand curve to left. New Aggregate Demand curve cuts the aggregate supply curve at a lower price level. So, inflation declines.

However, in the process, the real GDP level will decline indicating fall in the employment level and increase in the unemployment level.

So, Actual Inflation will decline and the unemployment level will increase.

Option c. is correct

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