spending. Howeressioreduce interest e pproaches government can take to move an h
ID: 1163661 • Letter: S
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spending. Howeressioreduce interest e pproaches government can take to move an how is it supposed to work (i.e., its strengths as a Keynesian theory tells us that there are three economy out of government can take to move an recession-reduce interest rates, reduce taxes, and increase government ever, in practice these approaches may not work. For each approach, discuss (1) its weakneses as or its strengths as a policy tool) and (2) why it might not work (i.e 2. An analysis of today's unemployment problem shows that some unemployment is "eyclical." but some is "frictional," some is "structural" and some is "hidden" (and not counted). Explain these four sources of unemployment and explain how each contributes to the current unemployment problem facing the USExplanation / Answer
1.
The first approach is to reduce the interest rate. It will encourage people and firms to spend more in the form of consumption and investment spending. It will increase the aggregate demand that will be catered by the increased supply. It will create new jobs and a cycle of positive economic activities will take place and the economy will come out of recession. The second approach is decrease taxes. It will work as it will increase the disposable income and people will spend more as per the marginal propensity to consume. It will increase the demand, catered by the supply. It will help the economy to recover. The third approach is increase in spending. It will help to stimulate the demand. It will be catered by the supply and again, employment will be created. Hence, increase in spending with its multiplier effect, will put the economy out of recession and recover.
Though, these approaches may not work also. The first approach will not work, because firms already plan their investment spending and they don’t respond to the sudden decrease in interest rate. The second approach of decrease in tax, will not affect consumers and they will save more on the basis of Ricardian Equivalence. Here, consumers think that reduced taxes today, will make the government to increase the tax in future. So, they save more and approach of reduction in tax, fails. The increase in government spending, suffers from the crowding out effect. Government spending, causes wiping out of the funds and firms get funds at higher interest rates. It discourages them. So, benefits of government spending is nullified. Hence, this approach suffers due to crowding out effect.
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