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The Role of Aggregate

Demand in Reducing
unemployment
14 November 2007 by Tejvan Pettinger

Evaluate the importance of

managing aggregate demand
(AD) to bring about a
sustained reduction in the
rate of unemployment in the
UK economy.

In 1992 Unemployment in the UK rose

to 3 million. A signiBcant part of this
unemployment this was due to the
recession of 1992.

In a recession, demand deBcient

unemployment will increase. This is
because as Brms close down they have
to lay oI workers. Other Brms, may
stay in business by not hiring new
workers or laying oI some existing
workers. In a recession, we get a rise in
unemployment due to deBciency of
aggregate demand.

Increasing AD to increase
employment

Therefore, in this case, it is important

for the government to try and boost
Aggregate Demand (AD) and increase
the rate of economic growth. For
example, the government could pursue
expansionary Bscal policy; e.g – lower
taxes and higher government spending.
This will lead to an increase in AD and
therefore, higher growth and jobs will
be created reducing unemployment.

Governments may be reluctant to

pursue expansionary Bscal policy
because it will lead to higher
borrowing.

Also, if AD increases too quickly it will

cause inUation. Therefore, the growth
may be unsustainable and the boom
may lead to a bust. In this case, the job
creation will only be temporary.
Therefore, it is important to manage
AD, so as to maintain stable, low
inUationary growth. This will allow a
sustained reduction in unemployment.
To a large extent, this is what has
happened in the UK since 1992. The
MPC used monetary policy (changing
interest rates) to enable low inUation
and stable growth from 1992-2007. In
2009, the rise in unemployment caused
the MPC to cut interest rates to 0.5% –
in a bid to boost aggregate demand
and create jobs.

AD is very important. However, there

are many other types of
unemployment which will not be
reduced through demand
management.

These include:

Frictional unemployment
(looking between jobs)
Structural unemployment. –
People without the right skills for
the labour market
Geographical unemployment – a
mismatch of skills throughout
the country.
Real wage unemployment –
caused by wages being above
equilibrium levels.
disguised unemployment – when
people are put on sickness
beneBts. (not counted in o_cial
JSA measure) See true level of
unemployment in the UK
Voluntary unemployment – when
beneBts are too high they
encourage people to remain on
beneBts rather than work.

E.g. It is argued that if the EU

experienced faster growth,
unemployment will still remain a
problem because of structural supply-
side factors. Often know as the natural
of unemployment. To achieve full
employment it is necessary to use
supply-side policies as well. Supply-side
policies can include

More Uexible labour markets

Retraining for the long-term
unemployed
Improved geographical mobility.

Related Essays:

Natural Rate of Unemployment 

Causes of unemployment
Policies to reduce
unemployment

 unemployment
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5 thoughts on “The Role of

Aggregate Demand in Reducing
unemployment”

Pingback: Unemployment Spain - How

to Reduce | Economics Blog

Pingback: Unemployment Levels and

InUation — Economics Blog

NIKOLAI NIkolaev
12 January 2009 at 9:45 pm

Hey i believe that

unemployemtn can be
decreased with subsidies. If we
all followed Senator Judis’
plans, this mess wouldn’t have
occured.

CONNOR BARNES
26 March 2009 at 9:38 pm

I BELIEVE THAT
UNEMPLOYMENT CAN BE
DECREASED THRU GOV
SPENDIN

CONNOR BARNES
26 March 2009 at 9:40 pm

also unemployment could be

lower if we provided more tax
incentives too work

Comments are closed.

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Tejvan Pettinger studied PPE at LMH,

Oxford University. Find out more

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