According to Keynesian economics, how should the government respond to high unemployment?

• A. Increasing government spending
• B. Decreasing money supply
• C. Balancing the budget
• D. Not doing anything

Answer: (A)

When unemployment is high, the aim is to raise aggregate demand so firms hire more workers and produce more goods. Keynesians favor expansionary fiscal policy to do this, and increasing government spending directly boosts demand for goods and services. The idea is that government purchases put money into the economy, which circulates through the multiplier and leads to higher output and lower unemployment, especially when resources are idle.

Raising government spending is more effective in this context than changing the money supply, balancing the budget, or doing nothing. Cutting the money supply would contract credit and reduce investment, worsening unemployment. Balancing the budget would cut spending or raise taxes, reducing aggregate demand and making the recession deeper. Doing nothing leaves demand weak and unemployment high with no stimulus.