Question

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.

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

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

Answer 1

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

Reason: To reduce high inflation Gino would use contractionary fiscal policy (cut spending or raise taxes), which lowers aggregate demand → output falls and unemployment rises. Lower demand for loanable funds/shift of the IS curve reduces equilibrium interest rates.