Question

1. Assume the economy is in short-run equilibrium with significant unemployment. The Central Bank policymakers do not want the interest rates to fall, and there is no current threat of inflation. What course of action can the policymakers follow to move the economy toward full employment? Should they use monetary policy? Explain how they should do that.

Answer 1

The short run equilibrium occurs when aggregate demand curve intersects the aggregate supply curve, this can cause either recessionary gap or inflationary gap. Here we can see that the economy is in short run equilibirium and so to move the economy towards full employment without the reduction of the interest rates, the best policy to implement is fiscal policy. The reason is because, using monetory policy will cause reduction in interest rates to increase supply of money in the economy, which will increase borrowings and encourage investments for the growth of the economy.

So to increase employement the government needs to stimulate growth, to do that without effecting the interest rates, the government uses expansionary fiscal policy. To implement this government either cut taxes, increases government spending or does both to increase the cash in hand of the consumers which will ecourage more investments and increases employment. Speaking economicaly this will help in shifting the aggregate demand curve to the right increasing the GDP of the country.