If you were an advisor to the government what would you suggest could be done to significantly reduce the national level of unemployment.
The economy of country X is in a slowdown and we have cyclical unemployment. In the short run demand determines supply. This means that we have excess capacity, i. e. the economy works under capacity. Due to decreased aggregate demand we have decreased demand for labor. In the short run the prices are rigid, so this decreased demand for labor is expressed as a direct unemployment. Our task in the short run is to try to reduce the level of this kind of unemployment. .
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Our first step is to try to increase aggregate demand. Increasing aggregate demand, we will increase output and the increased output will increase the demand for labor. Aggregate demand consists of Consumption, Investment, Government expenditures and Net exports. The first thing we could do is to increase government expenditures. The increased government expenditures will shift aggregate expenditures schedule up and so increase aggregate demand. So let's apply this fiscal policy. It is very important where our government is going to spend its money. I intend to advice the government to increase its expenditures in sphere of public investment in the infrastructure of the country and the human capital. This will pay off to our future generations in the long run. But in the short run the increased government expenditures will distribute as an income among households and will shift the consumption function up. But here we have a certain drawback. The increased expenditures without proportionate increase in taxes will increase government indebtness or the deficit. This implies two concerns. First even fiscal stimulus makes us better now, future generations are saddled with debt which makes them worse off. But after our government spent its extra expenditures in public investment I expect that the return on those investment will exceed the interest rate.
