Question

Which of these accurately explains the impact of an expansionary policy on interest rates, inflation, and unemployment?
Responses

Government spending with an expansionary policy can reduce inflation and interest rates but can increase unemployment.
Government spending with an expansionary policy can reduce inflation and interest rates but can increase unemployment.

Government spending with an expansionary policy can increase interest rates and inflation but can reduce unemployment.
Government spending with an expansionary policy can increase interest rates and inflation but can reduce unemployment.

Government spending with an expansionary policy can increase unemployment and interest rates but can reduce inflation.
Government spending with an expansionary policy can increase unemployment and interest rates but can reduce inflation.

Government spending with an expansionary policy can reduce interest rates and unemployment but can increase inflation.

Answer 1

Correct choice:
"Government spending with an expansionary policy can increase interest rates and inflation but can reduce unemployment."

Why: Expansionary fiscal policy (higher government spending) shifts aggregate demand right, raising output and lowering unemployment in the short run. Higher demand tends to push up the price level (inflation). Increased government spending also raises the demand for loanable funds (or prompts higher inflation expectations), which tends to raise real and/or nominal interest rates (the crowding‑out effect).

Caveat: If the central bank accommodates the fiscal expansion (increases money supply) or the economy is at the zero lower bound, interest rates may not rise. Long‑run effects depend on monetary policy and supply‑side responses.