Question

4. What are the potential risks of using government policy to try to increase productivity?

Answer 1

The downside of devaluation is that it can bring economic hardship in the short term. Rising import prices are raising inflation and lowering living standards. Devaluation is often seen as a symbol of weakness both economically and politically. Demand-side policies can not increase the growth rate above the long-run trend rate without triggering an unsustainable boom and bust.

The UK chancellor, Anthony Barber, for example, declared a 'race for prosperity' in 1972. Taxes have been lowered against a backdrop of rising house prices and inflation. That led to the Barber boom rapid growth in the economy. It also caused inflation to rise, however, and the growth proved unsustainable.

In certain situations, demand-side policies must be employed to restrict aggregate demand growth. An economic boom, in which development becomes unsustainable and inflationary, must be stopped. Managing AD to stop boom and bust cycles will help to produce a longer period of economic development.

Lower Tax Income. Lower income tax is argued that will raise motivation to work and increase supply of labour. If income taxes were high, then cutting them might motivate people to work more. This claim sometimes gets exaggerated, though. Reducing the basic income tax rate from 23 to 22 per cent would have a very small effect on the supply of labor. There is an effect of both income and replacement with a tax cut. The effect on revenue notes that higher taxes make people work more hours to meet their target income. (Tax saving economies)

In a recession supply-side policies do not address the fundamental issue of aggregate demand deficiency. In a recession, growing labor market stability and promoting investment will help to some degree. But companies would be hesitant to increase production and set up new business projects when there is ample demand. For example, the ECB president discussed a 'growth pact' in how to tackle youth unemployment. Although, this growth pact just looks at supply side policies and not the lack of demand in high unemployment countries.