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Government Policy Measures, Unemployment, and Inflation


In February 2016, share prices on stock exchanges fell throughout the world. There were a number of reasons for this; including concerns about the slowdown in world growth, the possibility of deflation and unemployment, and fears that some commercial banks could go out of business

Discuss whether or not government policy measures to reduce unemployment will cause inflation.


Macroeconomic Factors and Policies

[CIE O level November 2018]

Preview Answer

Step 1 : Define ‘ unemployment’ and ‘inflation in the introduction.

Economists believe that there is a trade-off between unemployment and inflation. Consequently, government policy measures to reduce unemployment may actually cause inflation. The unemployment rate measures the proportion of the labour that is willing and able to work, but without work. Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time.

Step 2 : Discuss how policies to reduce unemployment might cause inflation.

The government may use expansionary fiscal policy and expansionary monetary policy to reduce unemployment. However, this policy can also cause inflation.

Expansionary fiscal policy involves cutting taxes and increasing government spending. Monetary policy would involve cutting interest rates. Lower rates decrease the cost of borrowing and encourage people to spend and invest. These policies will increase aggregate demand, help to increase national income and reduce demand deficient unemployment. This can be shown in the diagram below.

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