What Is a Stimulus Package?
A stimulus package is a package of economic measures put together by a government to stimulate a floundering economy. The objective of a stimulus package is to reinvigorate the economy and prevent or reverse a recession by boosting employment and spending.
The theory behind the usefulness of a stimulus package is rooted in Keynesian economics, which argues that the impact of a recession can be lessened with increased government spending.
- A stimulus package is a coordinated effort to increase government spending and lower taxes and interest rates in order to stimulate an economy out of a recession or depression.
- Based on principles outlined by Keynesian economics, the goal is to increase aggregate demand through increased employment, consumer spending, and investment.
- Stimulus packages may involve expansionary fiscal or monetary policy or both.
How Stimulus Packages Work
A stimulus package is a number of incentives and tax rebates offered by a government to boost spending in a bid to pull a country out of a recession or to prevent an economic slowdown. A stimulus package can either be in the form of a monetary stimulus or a fiscal stimulus. A monetary stimulus involves cutting interest rates to stimulate the economy. When interest rates are cut, there is more incentive for people to borrow as the cost of borrowing is reduced.
An increase in borrowing means there’ll be more money in circulation, less incentive to save, and more incentive to spend. Lowering interest rates could also weaken the exchange rate of a country, thereby leading to a boost in exports. When exports are increased, more money enters the economy, encouraging spending and stirring up the economy.
The downside of fiscal stimulus is a higher debt-to-GDP ratio and the risk of consumers hoarding any cash given to them instead of spending the money.
Stimulus Package in Practice
Another form of monetary stimulus is quantitative easing, an expansionary monetary policy in which the central bank of a country purchases a large number of financial assets, such as bonds, from commercial banks and other financial institutions. The purchase of these assets in large amounts increases the excess reserves held by the financial institutions, facilitates lending, increases the money supply in circulation, drives up the price of bonds, lowers the yield, and lowers interest rates. A government will usually opt for quantitative easing when a conventional monetary stimulus is no longer effective.
Following the vote to leave the European Union, the Bank of England designed a stimulus package to prevent the country from going into a recession. Part of the stimulus package included a quantitative easing plan to purchase £10 billion worth of corporate debt from a pool of £150 billion in order to drive down borrowing costs. Interest rates were also cut to 0.25% from 0.50%.
When a government opts for a fiscal stimulus, it cuts taxes or increases its spending in a bid to revive the economy. When taxes are cut, people have more income at their disposal. An increase in disposable income means more spending in the country to boost economic growth. When the government increases its spending, it injects more money into the economy, which decreases the unemployment rate, increases spending, and eventually, counters the impact of a recession.
The amount of the 2009 government stimulus package, meant to cushion the blow of the U.S. recession—stemming from the credit crisis—and help revive the economy.
The 2008-09 Financial Crisis
The global recession of 2008-2009 led to unprecedented stimulus packages being unveiled by governments around the world. In the United States, A $787-billion stimulus package known as the American Recovery and Reinvestment Act (ARRA) of 2009 contained a huge array of tax breaks and spending projects aimed at vigorous job creation and a swift revival of the U.S. economy. The stimulus package consisted of tax rebates that cut taxes by $288 billion, $275 billion allocated to federal contracts and grants to foster job creation, and $224 billion assigned to unemployment assistance, healthcare, and education to keep the economy afloat.
A potential problem of fiscal stimulus is that to increase public spending, the government has to increase its borrowing, which would lead to a higher Debt-to-GDP ratio. Also, people may actually choose to save the excess disposable income instead of spending it, which could render the stimulus package ineffective.