Question

which statement best describes the likely effects of an expansionary fiscal policy?
○ it can increase interest rates and unemployment, but lower inflation.
○ it can increase interest rates, unemployment and inflation.
○ it can reduce interest rates and inflation, but increase unemployment.
○ it can reduce interest rates and unemployment, but increase inflation.

Explanation:

Expansionary fiscal policy (e.g., increased government spending, tax cuts) boosts aggregate demand. This stimulates economic activity, reducing unemployment (as businesses hire more). It can lower interest rates (more spending/investment reduces rate pressure? Wait, no—wait, expansionary fiscal policy increases government borrowing, which can increase interest rates? Wait, no, maybe I mixed with monetary. Wait, fiscal: when government spends more, AD increases. So output rises, unemployment falls. Demand - pull inflation may rise. Also, if government borrows more, it can increase interest rates (crowding out), but the main effects: lower unemployment, possible higher inflation, and maybe lower interest rates? Wait, no, let's recall: Expansionary fiscal policy (G up, T down) shifts AD right. So real GDP increases, unemployment decreases (since more production, more jobs). Price level (inflation) increases (demand - pull). Now, interest rates: if the economy is in a recession, expansionary fiscal policy can increase income, which increases money demand, so interest rates rise (but maybe the central bank accommodates). Wait, the options: Let's analyze each option:

1. "It can increase interest rates and unemployment, but lower inflation." → Unemployment should decrease, inflation increase. Wrong.

1. "It can increase interest rates, unemployment and inflation." → Unemployment should decrease. Wrong.

1. "It can reduce interest rates and inflation, but increase unemployment." → All opposite. Wrong.

1. "It can reduce interest rates and unemployment, but increase inflation." → Wait, maybe the central bank responds with expansionary monetary policy (to keep interest rates low), so interest rates reduce. Unemployment reduces (more jobs), inflation increases (demand - pull). So this option: reduce unemployment (correct), reduce interest rates (if monetary policy eases), increase inflation (correct). So this is the best.

Answer:

It can reduce interest rates and unemployment, but increase inflation.