Inflation and Unemployment in Bavaria - Special Academic Support

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Expansionist fiscal policy is a series of government measures aimed at increasing aggregate demand. They involve cutting net taxes or increasing government purchases and may reduce the number of unemployed. According to the Keynesian theory, such actions should be taken only to overcome the economic recession and stabilize the countrys economic activities. Some governments may wish to improve the well-being of their citizens using such a policy even at a time of stable development. However, in this case, inflation becomes the result of such an administrations actions. Although expansionist fiscal policy can reduce the unemployment rate for short period, in the long run, after the markets adaption to the changes it will have negative consequences increasing wages and leading to unemployment again.

Reducing unemployment will contribute to rising prices and wages, and its growth, on the contrary, will slow them down. This inverse relationship is justified by structural changes in the labor market while reducing unemployment. When the economy is at the normal level of the gross national product, and close to full employment, expansionary fiscal policies will increase demand. Then, a short-term balance will be established between prices, products, and demand. In this case, product prices will begin to rise, and the unemployment rate will decrease. After that, however, higher prices would increase wages, and production costs, leading to lower output and a number of staff cuts, again growing unemployment. Thus, such a policy will only change prices upward.

In the long term, workers and entrepreneurs are adapting to a new level of inflation, and unemployment is returning to its previous level. In this way, inflation becomes a crisis phenomenon and a dangerous process with a negative impact on the economy. Because of this process, the decline in real income, and devaluation of citizens savings occurs. Considering the normal state of the economy and the existing level of employment close to full, the President of Bavaria is not recommended to pursue an expansionary fiscal policy, avoiding its harmful consequences.

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