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 recessions are not self-correcting, and therefore government intervention can lessen the impact of a recession. This happens because increased government spending makes up for the decreased private spending, thereby boosting overall aggregate demand to close 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—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.
  • The U.S. Senate voted to approve a $2 trillion stimulus bill on March 25, 2020, to backstop the economy from the economic impact of the coronavirus. President Trump signed the CARES Act into law on March 27.

On March 27, 2020, President Trump signed into law the CARES Act, a stimulus bill totaling more than $2 trillion, to provide relief to individuals, families, small businesses, and industries impacted by the economic slowdown caused by the coronavirus pandemic. 

How Stimulus Packages Work

A stimulus package 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. Quantitative easing (QE) is another form of monetary stimulus.

Monetary 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.

Fiscal stimulus

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 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, which could render the stimulus package ineffective.

Quantitative easing

This is 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.

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, the Bank of England (BoE) in August 2016 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 QE program to £445 billion. Interest rates were also cut to 0.25% from 0.50%.

$787 billion

The amount of the 2009 government stimulus package, meant to cushion the blow of the Great Recession in the U.S. 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 initial cost projections of the stimulus package consisted of $212 billion in tax rebates, $296 billion extra for Medicaid, unemployment benefits and other mandatory programs, and an additional $279 billion in discretionary spending to keep the economy afloat.