Chapter 17, Problem 23AA

To determine

To evaluate the reason behind the rise of unemployment if fiscal policy were used to combat inflation.

Explanation of Solution

Fiscal policies can’t eliminate unemployment on the supply side. If there is frictional or structural unemployment, it will not be fixed by fiscal policy. Suppose any of the former miners are unemployed, for example. Here the problem is lack of expertise and geographic immobility. So supply-side policies are what is required. Rising AD and economic development would not address the skills shortages. Therefore, classical economics are right when the economy is at maximum potential. If the economy rises, and the government pursues monetary policy, reducing unemployment is likely to be unsuccessful.

Higher government borrowing would cause crowding out at near to full employment (government borrowing decreases the size of the private sector and decreases private sector investment). As well, higher government borrowing will drive up bond yields in a rising economy, and higher interest rates will limit private-sector investment.Also, people will see higher inflation if the economy is at full employment and the government pursues expansionary fiscal policy.

Economics Concept Introduction

Introduction: Fiscal policy is the process in which a government alters its levels of spending and rates of tax to regulate and manage a country's economy. It's the sister monetary policy, in which a federal reserve controls a country's money supply.