Downturns in the business cycle cause cyclical unemployment, so policymakers should focus on expanding output, which they can best achieve by stimulating demand. During a downturn, businesses face declining revenues and find themselves forced to cut costs. As a consequence, they lay off workers. Policymakers need to stimulate demand to prevent this loss of revenue, and they rely mainly on expansionary monetary and fiscal policy to achieve this. Additionally, they may also introduce specific legislation and initiatives aimed at creating jobs and boosting demand.

Monetary Policy

Monetary policy entails managing output and employment by managing the supply of money. To raise consumer demand, the Federal Reserve (the Fed) increases the supply of money in the economy by lowering the interest rate and making it more attractive for banks to borrow from the Fed. When banks borrow more, they have more capital available and are more willing to give loans to individuals and businesses, which spend those loans on goods and services, raising overall demand.

Fiscal Policy

Fiscal policy entails managing output and employment through government spending and taxation. When the government increases spending, for example, by beginning a public construction project, the overall level of demand in the economy rises and more jobs are created. Likewise, if the government institutes a tax cut, individuals and businesses have more money to spend than before, which raises overall demand.

Sometimes, policymakers may also use specific initiatives for reducing unemployment and creating output to target particular areas of the economy or resolve particularly difficult problems. A few examples that have been discussed in the wake of the Great Recession include streamlining the approval process for government projects that create jobs, giving businesses cash incentives for hiring workers and paying businesses to train workers to fill specific positions.