Question

How does the policy that Gino is describing most likely affect interest rates and unemployment?

Gino is writing a paper about the effects of fiscal policies on the economy. Gino is describing a fiscal policy that aims to improve inflation.

Responses

The policy would most likely increase interest rates but decrease unemployment.
The policy would most likely increase interest rates but decrease unemployment.

The policy would most likely increase unemployment but decrease interest rates.
The policy would most likely increase unemployment but decrease interest rates.

The policy would most likely increase interest rates and unemployment.
The policy would most likely increase interest rates and unemployment.

The policy would most likely decrease interest rates and unemployment.

Answer 1

The policy most likely increases unemployment but decreases interest rates.

Reason: To reduce high inflation policymakers use contractionary fiscal policy (higher taxes or lower spending). That lowers aggregate demand → output falls and unemployment rises. Lower demand for goods and for loanable funds also tends to push interest rates down (IS curve shifts left in the short run).