Answer to Question #121110 in Macroeconomics for Ruby

Question

Assume “Skill India” policy implemented by Ministry of Skill Development and Entrepreneurship (MSDE) in 2014 is doing well and has been successful in helping many workers learn new skills. Further, the program has reduced the structural (or, natural) rate of unemployment in India, un.
a) Using the concept of Phillips curve, comment on how the reduction in un is beneficial for the economy?
b) The opposition claimed that government program is expensive. Instead, the expansionary monetary policy could have been a cheaper way to cut the unemployment. Comment.

Answer 1

a) The Philips curve shows the tradeoff between inflation and unemployment in the economy. According to the Philips curve, unemployment and inflation have a stable inverse relationship whereby an increase in the inflation rate leads to a decrease in the unemployment level. According to the theory, despite economic growth being good for the economy since it leads to creation of more jobs and other opportunities it is nevertheless associated with some level of inflation. 

A reduction in the unemployment rate as shown by the arrows above not only leads to creation of more jobs but also causes an increase in the interest rate which is associated with inflation. For economic growth to be healthy, there is some level of inflation that should be maintained and the Central Bank keeps a watch on the inflation target to ensure healthy economic growth. 

b)Expansionary monetary policy 

Expansionary monetary policy involves lowering interest rates so as to boost the aggregate demand (AD). In the end, consumers, business and investors have more money at their disposal since they are able to borrow loans from commercial banks at a cheap and affordable rate. Thus, the expansionary monetary policy will motivate consumers to spend and invest causing the aggregate demand to shift to the right. Ideally, this will consequently help increase the gross domestic product (GDP) and reduce demand deficit unemployment. Lower interest rates will reduce exchange rate and make exports more competitive. The government program represents a Keynesian view of lowering unemployment rate. Indeed, though the monetary policy has a potential of lowering the unemployment level, it might not be quite effective since a significant proportion of the population might not be motivated to take up loans so as to spend or invest and as such, the monetary policy will be less effective as compared to the government program.