In a recession, fiscal policy and monetary policy can, in theory be used to increase Aggregate Demand and boost economic growth. However in practice there can be many difficulties with boosting a countries economic growth rate and reducing unemployment.
1. Confidence. In a recession confidence may be so low that cuts in interest rates and taxes do not have the effect of increasing demand. For example the liquidity trap says that lower interest rates are ineffective in increasing spending because they do not change people’s behaviour at certain times
2. Hysteresis. This is an argument that when unemployment is high it is difficult to change that fact. - Workers become deskilled and demotivated. Therefore, even an increase in AD doesn’t solve unemployment because many workers don’t have the relevant skills and capacities to get a job.
3. Paradox of Thrift. - In a recession people often want to save. But, this just makes the recession worse. It can lead to a negative multiplier effect. A fall in spending leads to less output. Lower output creates unemployment and so even more people have less skills.
