Inflation is a persistent rise in the general price level. The increase leads to a considerable and prolonged fall in consumers’ purchasing power (PP) in an economy over some time. The loss of PP influences the overall living cost for the average household, which contributes to a slowdown in economic growth. Unemployment can be identified as a situation where an individual of working age cannot find a job but would like to be fully employed. The unemployment rate, found by dividing the total number of unemployed people by the total number of people in the workforce, acts as one of the critical indicators of an economy’s position and status. An increase in inflation or unemployment is subject to action on the part of the government. Monetary and fiscal policies are the primary tools in dealing with economic challenges. In this essay, an attempt will be made to analyze how legal authorities exploit the instruments mentioned above in response to alterations in inflation and unemployment activities.
The principal approach for keeping inflation down is contractionary monetary policy, where an interest rate increase reduces demand, helping to regulate the inflation level. A contractionary monetary policy aims at restricting the supply of money by increasing interest rates within an entire economy. A rise in the cost of borrowing will discourage consumer spending as well as investment level. Elevated prices will not only prevent excessive consumption but also make saving an attractive alternative for upcoming hard times. Lowering expenditure is vital during inflation as a corresponding reduction in aggregate demand (AD) will accompany it. Moreover, the policy can deplete the net income of those with mortgages. Higher rates of interest escalate the exchange rate value, resulting in lower exports and more imports figures. Hence, the monetary policy is effective for inflation regulation when the government raises the borrowing cost.
One of the limitations of the monetary policy is the period between the action and its outcome. According to Alvarez and Sanchez (2018), the decision on the implementation should be made “in a forward-looking manner to maintain price stability over long periods” (p. 3). Indeed, the negotiation process, red tapes, and reaction to changes take time to occur. What is more, most developing economies experience financial illiteracy and irrationality. They do not comprehend the importance of various banking activities, ignoring the opportunities for money deposits and loans. Thus, the government faces some problems regarding backlog in time and consumers’ ignorance.
The execution of the fiscal policy involves the manipulation of government spending and taxation. In the case of an increased inflation rate, the tightening procedure can be used where taxes are boosted and expenditure is cut. The government intervenes by raising the taxation level, decreasing the amount of money available to spend. Consequently, reduced consumption acts as a signal to businesses that revenue levels are going to fall, thus, forcing firms to reduce prices to stay in the business. Following the law of demand, lower prices will improve demand, and the average price level will drop. Thereby, inflation can be controlled under the realization of fiscal guidelines via maneuvering of the government funds.
Despite the rationale behind the policy workings, there are issues concerning the political side of the matter. Fiscal policy can be costly to public officials since government borrowing is likely to be limited. Any measures, including government state money, bear the risk of upward bias. Furthermore, the performance of the policy is fraught with higher rates of interest and long-lasting deficits (D’Acunto, Hoang, & Weber, 2018). To be more precise, a budget deficit happens when authorities spend more money annually than available in the public treasury. Aggressive fiscal actions may facilitate a deficit that can grow to dangerous levels. Thereupon, the government’s judgment on how to apply fiscal strategies can be impacted by politics.
The monetary policy, intended for decreasing the unemployment rate, requires cutting interest rates. Since the tactic is designed to reach the point of full employment, lower rates make the borrowing cost fall, stimulating consumers to spend and producers to invest (Selim & Hassan, 2018). This will be followed by a rise in aggregate demand and contribute to an increase in the gross domestic product (GDP). Given that declined interest rates will depreciate the exchange rate, exports might become more competitive, adding another growing element to AD. On top of that, price stability and high demand for goods foster firms to hire more workers, surging employment rates. Thus, monetary policy influences the unemployment level by establishing interest rates and affecting demand for goods and services.
Fiscal policy can potentially reduce unemployment by assisting in an increase in AD and the economic growth rate. Taking into account the strategy’s fundamental goal, the government needs to select an expansionary form of fiscal policy (Obayori, 2016). Lowered taxes will boost disposable income and push consumption, leading to higher aggregate demand. Provided that there is spare capacity in an economy, a raise in the latter can be coupled with a climb in GDP. As firms manufacture more output, there will be an increase in demand for employers and, therefore, a lower unemployment rate. At the same time, fewer businesses will go bankrupt, meaning workers can secure their job places. Hence, the fiscal stance on controlling and reducing unemployment rates appears to be efficient for the government to use.
Nevertheless, legislative authorities may encounter some obstacles in taking advantage of the policy’s opportunities. If unemployment is caused by supply-side inefficiencies, fiscal policy will not remedy the issue. Structural unemployment is a type of unemployment where there is inefficacy in the labor market due to the geographical location or mismatch of working skills. For instance, an unemployed former miner lacks proficiency in teaching and can be geographically immobile to move and live in other places. The traditional fiscal policy does not solve the disparity between diverse abilities required to apply for particular vacancies. Therefore, for the growing economy, the government should consider the routes of unemployment before pursuing fiscal policy as it is likely to be ineffective in reducing idleness.
In conclusion, it can be noted that government can cure inflation and unemployment using both strategies. The fiscal policy can be utilized by cutting government spending and raising taxation. Aggregate demand will fall, leading to a drop in the general price level. The reverse will happen to AD contributing to an increase in output, giving rise to employment rates. The monetary tactic might be implemented by boosting interest rates and, thus, discouraging consumer spending and investment. Ultimately, it will result in lower AD, allowing to moderate inflation level. Alternatively, AD will climb to achieve full employment of resources.
Alvarez, L. & Sanchez I. (2018). Inflation projections for monetary policy decision making. Journal of Policy Modeling, 41(4), 1-28. Web.
D’Acunto, F., Hoang, D., & Weber, M. (2018). Unconventional fiscal policy. AEA Papers and Proceedings, 108, 519-523.
Obayori, J. B. (2016). Fiscal policy and unemployment in Nigeria. Valley International Journals, 3(2), 1887-1891.
Selim, M. & Hassam, M. K. (2019). Interest-free monetary policy and its impact on inflation and unemployment rates. International Journal of Islamic Finance, 11(1), 46-61.