Final answer:
A contractionary fiscal policy increases unemployment and interest rates to combat inflation, while an expansionary fiscal policy increases the number of jobs, can reduce interest rates, but may increase inflation.
Step-by-step explanation:
A contractionary fiscal policy is implemented to reduce inflation when an economy is producing above its potential GDP. This policy involves decreasing the level of aggregate demand through either cuts in government spending or increases in taxes, which can lead to higher unemployment and potentially increase interest rates as the government borrows less. On the other side, an expansionary fiscal policy is designed to stimulate an economy during a recession, increasing the number of jobs by raising aggregate demand through lower taxes or increased government spending. Such policies often lead to decreased interest rates and can sometimes increase inflation due to the greater demand for goods and services.
As such, the correct answer to the student's question would be:
- A contractionary fiscal policy can increase unemployment and interest rates.
- An expansionary fiscal policy can increase the number of jobs and reduce interest rates, but it may increase inflation.
Therefore, the correct sequence of terms for the blanks provided in the original question is: 1) increase, 2) increase, 3) decrease.