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The conventional wisdom holds that the government should expand the money supply and should spend more and tax less when it is faced with rising unemployment.
When there is excessive unemployment, one thing that the government wants to do is to increase aggregate demand. This involves putting more money into the hands of the people. The government can do this through an expansionary fiscal policy. The government could, for example, reduce taxes. When taxes are reduced, people have more disposable income. They can use the money to buy more goods and services. When this happens, more workers will be needed to provide those goods and services and unemployment will drop.
The government can also increase the supply of money through monetary policy. One way to do this is by lowering interest rates. When interest rates are lowered, it becomes less expensive to borrow money. Consumers will be more able to borrow money so that they can afford big ticket items like houses and cars. When they buy more of these items, unemployment declines as more people are hired to produce the goods.
Thus, the government should in this case lower taxes and/or increase spending. It should also pursue an “easy money” policy such as reducing interest rates.
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