What discretionary fiscal policy option should the goverment use to restore full employment?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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For the purposes of this answer, I will assume that you need to restore the economy to full employment from a point where the unemployment rate is too high.  In other words, I assume that this economy suffers from high unemployment rather than high inflation.  (If it suffered from high inflation, it might need to actually raise the unemployment rate to reach full employment.)

If an economy suffers from high unemployment, the government needs to (according to Keynesian thinking) get more money into the hands of the people.  The people will take the money and spend it.  Aggregate demand will increase and real Gross Domestic Product will rise.  As more workers are needed to make more products, unemployment will fall.

There are two aspects to a fiscal policy that would lower unemployment.  First, the government is supposed to lower taxes.  As taxes go down, people keep more of their wages.  They can then spend that money, increasing aggregate demand.  Second, the government is supposed to spend more money.  The government needs to hire more people for government jobs and/or buy more goods and services from private companies.  In both cases, the government is paying people to do work they would not otherwise have done.  This can decrease unemployment directly (by giving people jobs) and indirectly (because they will spend the money they earn, thus increasing aggregate demand).

In short, if unemployment is too high, Keynesian theory says that the proper fiscal policy is to lower taxes and increase government spending.