This reduction in the real domestic output can result in unemployment in the economy. The other effects of the reduction in aggregate demand have been mentioned below:
Wealth Effect: the reduction in aggregate demand will result in reduced aggregate expenditure as less quantity is demanded the spending will be reduced
Interest Rate Effect: Since the price will fall there will be reduction in interest rates as the amount not spent will be invested.
Thus the spending cuts that have been mentioned above will result in reduced aggregate demand and thus controlling inflation. Also the inflation will reduce as the budget deficit will come down. Similarly the interest rate effect will also be there as the government may buy back the bonds thus reducing the interest rates.
The Keynesian theory, during the great depression of 1930 argues that the government spending should be increased in order to situate demand in the economy. This has been explained above. The other measures that can be adopted by the government are to reduce the taxes. This will result in household income and thus will generate demand which will take the economy out of the recession. This step will take the government budget towards deficit but it will boost the growth in the economy.
However, at times the results have not been seen due to the lag that is there between the steps taken by the government and the response of economy. Further the Keynesian theory is based on fiscal policies. The monetary policy also has huge influence on the economy. Moreover, as explained by Phillips Curve, the stagflation resulted in inflation and unemployment. This is opposite of what has been postulated by Keynesians. Lastly the economy may not respond to small changes in the policies such as tax cuts and thus spending is not increased.