What Is a Stimulus Package?

A stimulus package is a package of economic measures a government invokes 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 recessions are not self-correcting; therefore, government intervention can lessen the impact of a recession. For example, a stimulus, or increased government spending, can compensate for decreased private spending, thereby boosting aggregate demand and closing the output gap in the economy.

Key Takeaways

  • A stimulus package is a coordinated effort to increase government spending—and lower taxes and interest rates—to stimulate an economy and lift it out of a recession or depression.
  • Based on Keynesian economics principles, the goal is to increase aggregate demand through increased employment, consumer spending, and investment.
  • The U.S. Senate approved various stimulus packages to help alleviate the effects of the COVID-19 epidemic in 2020 and 2021.

Understanding Stimulus Packages

On March 27, 2020, former President Trump signed into law the Coronavirus Aid, Relief, and Economic Security (CARES) Act, a stimulus bill totaling approximately $2.2 trillion, to provide relief to individuals, families, small businesses, and industries impacted by the economic slowdown caused by the coronavirus pandemic.

The fifth round of the COVID-19 stimulus was issued in December 2020. Then, in January 2021, President Joe Biden laid out a $1.9 trillion emergency relief plan. The plan included $1,400 checks for individuals, tax credits for children and lower-income workers, and new initiatives including paid sick and family medical leave for millions of workers, grants to small businesses, and $35 billion toward access to low-interest loans available, particularly for clean-energy investments.

These stimulus packages were all designed to relieve the economic struggle experienced by many Americans, particularly those with low incomes, and help businesses stay afloat during the pandemic. The COVID-19 pandemic caused a global recession and extreme measures were necessary to buoy up economies.

Types of Stimulus Packages

In times of economic recession that is less devastating than the COVID-19 pandemic, a stimulus package typically includes 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 be in the form of either a monetary stimulus or a fiscal stimulus, or quantitative easing.

Monetary Stimulus

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. When individuals and businesses borrow more, there is 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 boosting exports. When exports increase, more money enters the economy, encouraging spending and stimulating the economy.

Fiscal Stimulus

When a government opts for 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 people have more money to spend, which boosts demand, production, and 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.

Fiscal Stimulus Downside

The downside of fiscal stimulus is a higher debt-to-GDP ratio and the risk that consumers will hoard any cash given to them instead of spending it. If the latter occurs, the stimulus package could be ineffective.

Quantitative Easing

Quantitative easing is a type of expansionary monetary policy. Quantitative easing occurs when 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.

Examples of Stimulus Packages

In March 2020, several countries, including the United States (as noted above), scrambled to coordinate stimulus packages in response to the global coronavirus pandemic. This included cutting interest rates close to zero and providing stabilization mechanisms to the financial markets in conjunction with tax breaks, sector bailouts, and emergency unemployment support to displaced workers.

Following the vote to leave the European Union, in August 2016 the Bank of England (BoE) designed a stimulus package to prevent the country from going into a recession. Part of the stimulus package included additional quantitative easing to drive down borrowing costs. The bank's Monetary Policy Committee voted to purchase another £70 billion in debt (£60 billion of gilts and £10 billion worth of corporate debt), bringing its total quantitative easing program to £445 billion. Interest rates were also cut to 0.25% from 0.50%.

$832 billion

The amount of the 2009 government stimulus package designed to cushion the blow of the Great Recession in the United States and help revive the economy.

The 2008 Financial Crisis

The global recession of 2008 to 2009 led to unprecedented stimulus packages instituted by governments worldwide. In the United States, a 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 initial cost projection of $787 billion included $212 billion in tax cuts; $296 billion for Medicaid, unemployment benefits, and other programs; and an additional $279 billion in discretionary spending to keep the economy afloat. As of 2014, the original cost estimate was revised to $832 billion.

When Is a Stimulus Package Used?

Stimulus packages are often used in times when the economy risks entering a recession or when a recession is already underway. In this sense, stimulus packages are an example of Keynesian economic policy. The effectiveness of these policies is a subject of ongoing economic and political debate.

What Is the Difference Between Monetary and Fiscal Stimulus?

Monetary policy refers to actions taken by a nation’s central bank, such as lowering interest rates in an effort to reduce the cost of borrowing. By lowering rates, central banks hope to ease the debt burden on businesses and households while also encouraging more debt-based spending. Fiscal stimulus, on the other hand, refers to actions taken by the government. Examples of fiscal stimulus involve increasing public-sector employment, investing in new infrastructure, and providing government subsidies to industries and individuals.

Do Stimulus Packages Produce Inflation?

Economists disagree as to whether and under what circumstances stimulus packages cause inflation. On the one hand, some argue that stimulus packages are inherently inflationary because they increase the amount of money in circulation without increasing the economy's productive capacity. By this logic, inflation is the inevitable result of more money chasing the same quantity of goods and services. On the other hand, developed economies such as the United States, Canada, and Japan have repeatedly used large-scale stimulus packages in recent years and have, so far, not seen material increases in inflation. It remains to be seen what effect these stimulus packages will have on inflation in the future.