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Interest rates






In addition to fiscal policy, government (or the monetary authority, where this is independent of government) has available the tools of monetary policy. Monetary policy involves changing interest rates, or the money supply, in order to influence the economy. High interest rates are a symptom of a tight monetary policy. When interest rates are high firms find it more costly to borrow, and this makes them more reluctant to invest in expanding their busi­ness. Individuals with mortgages or bank loans are also hit by high interest rates since it costs more to make their loan repayments. Hence high interest rates tend to reduce demand in the economy—firms invest less, and those with mortgages have less to spend. Low interest rates tend to stimulate demand.

Unemployment

A downturn in economic activity causes an increase in unemployment. Indeed, it was the high unemployment of the 1930s that led to the establishment of the subject now known as macroeconomics, and unemployment is still a central concern of economics. During the Great Depression of the 1930s UK unemployment rose to nearly 20 per cent of the labour force, and even higher levels were reached in some other countries. Although in the 1950s and 1960s unemployment was consistently very low in most industrial countries, higher unemployment returned in the 1980s and 1990s. UK unemployment1 reached peaks of 12.2 per cent in 1986 and of 10.8 per cent in 1993 in the two recessions, while unemployment in France and Germany reached post' war highs of 12.5 and 11.7 per cent, respectively, in 1997. Japanese unemployment in June 2002 reached a level of 5.4 per cent, not seen there since the Second World War. By 2000 unemployment had fallen in Britain and the United States, but it was still relatively high in several European countries, such as Spain, Germany, and France (and it started to rise again in the United States in 2001/2). Accordingly, the analysis of the causes of, and potential cures for, unemploy­ment is still very high on the agenda of macroeconomics today, especially in the EU and Japan. A new bout of high unemployment can never be ruled out, even for those coun­tries where it has been low for some time.

The main method of reducing unemployment that eco­nomists developed early in the twentieth century was for governments to increase their spending and reduce taxes. Such deliberate use of government spending and taxes to influence the economy is known as fiscal policy. In Chapter 33 we will discuss why this long accepted policy no longer seems promising.






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