how economic stimulus works
over the course of a normal business cycle governments try to influence the pace and composition of economic growth using various tools at their disposal central governments including the u s federal government use fiscal and monetary policy tools to stimulate growth state and local governments can also engage in projects or policies that stimulate private sector investment economic stimulus refers to a targeted and conservative approach to expansionary economic policy instead of using monetary and fiscal policy to replace private sector spending economic stimulus is supposed to direct government deficit spending tax cuts lowered interest rates or new credit creation toward key sectors of the economy to take advantage of powerful multiplier effects that will indirectly increase private sector consumption and investment spending proponents of economic stimulus believe that this increased private sector spending will then boost the economy out of recession the goal is to achieve this stimulus response effect so that the private sector can do most of the work to fight the recession and to avoid risks such as hyperinflation or government defaults that might come with massive government deficits or extreme monetary policy by stimulating private sector growth stimulus deficit spending could allegedly even pay for itself through higher tax revenues resulting from faster growth 1fiscal stimulus refers to policy measures undertaken by a government that typically reduce taxes or regulations or increase government spending to boost economic activity monetary stimulus on the other hand refers to central bank actions such as lowering interest rates or purchasing securities in the market to make it easier or cheaper to borrow and invest a stimulus package is a coordinated combination of fiscal and monetary measures put together by a government to stimulate a floundering economy 2the concept of economic stimulus is associated with 20th century economist john maynard keynes a recession according to keynesian economics is a deficiency of aggregate demand where the economy will not self correct and reaches a new equilibrium with higher unemployment lower output and slower growth rates under this theory to combat recession the government should aim to restore aggregate demand and full employment through policies that make up for shortfalls in private sector consumption and business investment spending 34risks of economic stimulusthere are several counterarguments regarding the efficiency and long term benefits of economic stimulus some theorists believe that economic stimulus can actually delay or prevent private sector recovery from the actual cause of a recession according to this viewpoint it is misguided to target economic stimulus toward industries that are hardest hit by the recession because these are precisely the areas of the economy that may need to be cut back to adjust to real economic conditions other critiques about the effectiveness of economic stimulus revolve around how people respond to economic incentives economists have argued that consumers and businesses adjust their behavior in ways that offset the stimulus policy the response to the stimulus will not be a simple multiplier effect but will also include these offsetting behaviors one such theory is ricardian equivalence named for david ricardo s work dating back to the early 1800s which suggests that consumers internalize government spending decisions in a way that counterbalances stimulus measures in other words ricardo argued that consumers will spend less today if they believe they will pay higher future taxes to cover government deficits 5other critics of economic stimulus point to the crowding out of private investment the crowding out critique suggests that government deficit spending will reduce private investment in two ways examples of economic stimulus programsthose who have lived through the past few decades have had quite a few chances to see economic stimulus in action the economic shockwaves from the financial crisis of 2007 2008 and more recently the covid 19 pandemic forced fiscal and monetary policymakers into action the programs below represent just a small sampling of government efforts to steer the economy through the respective crises but they offer some insights into the potential benefits and shortcomings of economic stimulus policymakers often attempt to direct the benefits of economic stimulus toward specific industries or sectors when the u s auto industry struggled during the great recession the government instituted the cash for clunkers program which incentivized consumers to buy new fuel efficient vehicles to replace their old cars signed into law by then president barack obama and lasting for a short time frame in the summer of 2009 until its allocated funding was depleted cash for clunkers was intended to be a win win by stimulating a critical industry during the recession while also reducing pollution 6however critics argued that cash for clunkers led to a used vehicle shortage and higher car prices with much of the benefit going to foreign car manufacturers 78 the program succeeded in nudging consumers to trade in their gas guzzlers but it may have simply pushed forward a transaction that was going to happen anyway and the economic effect was short lived 9 even the environmental impact was mixed as the discarded clunkers generated hazardous waste from metal shredding and the program did not represent a cost effective way to cut emissions 10the coronavirus aid relief and economic security cares act signed into law by then president donald trump on march 27 2020 aimed to counteract the economic turmoil set into motion by the global covid 19 pandemic with concerns that the u s economy was heading into a recession policymakers passed a record 2 2 trillion stimulus bill to support large and small businesses industries individuals families gig workers independent contractors and the healthcare system 11the cares act took a multifaceted approach to stimulate the ailing economy during the early stages of the pandemic the legislation put money directly into the pockets of u s consumers authorizing direct stimulus payments of 1 200 per adult plus 500 per child for households making up to 75 000 with additional tax rebates for families with children the stimulus package also boosted unemployment benefits and helped small businesses hold onto their employees as far as targeting individual hard hit industries and sectors the cares act directed billions toward airlines to keep planes in the skies throughout the pandemic 11in addition to standing out for its massive price tag the cares act pushed the boundaries of economic stimulus by directly replacing large swaths of private sector spending that had been destroyed by the coronavirus 11 while the cares act may have been a needed response to the unprecedented economic shock of the pandemic the long term impact of the stimulus package remains difficult to quantify 