What Is Economic Stimulus?
An economic stimulus is a Keynesian economics-inspired policy that encourages private sector activity by engaging in targeted, expansive monetary or fiscal policy based on the teachings of John Maynard Keynes.
An economic stimulus is a policy measure by the government that is intended to spur economic activity and encourage job creation. The economic stimulus can take many forms, such as tax breaks, infrastructure spending, or monetary policies such as quantitative easing.
Derived from biology, the term economic stimulus is when government policy acts as a catalyst to produce a reaction from the private sector economy. The goal of an economic stimulus is to jumpstart the economy by spurring private sector activity and job creation. The economic stimulus can take many different forms, such as
- Tax breaks
- Increased government spending on infrastructure projects
- Monetary policy measures such as quantitative easing.
The global financial crisis of 2007-2008 led to widespread calls for economic stimulus measures to prevent a recession. In response, many governments implemented stimulus programs. The effectiveness of economic stimulus measures is a matter of much debate. Some economists argue that stimulus measures are ineffective and can do more harm than good. Others argue that stimulus measures can be effective if properly designed and implemented.
Understanding Economic Stimulus
When the federal government provides economic stimulus, it’s trying to jump-start the economy by giving money to people and businesses. The idea is that the recipients will then spend that money, which will help to create jobs and grow the economy.
The most recent example of economic stimulus came in the form of stimulus payments, also known as recovery rebate credits, which were sent out by the Internal Revenue Service (IRS) in early 2020. These payments were part of the Economic Security Act, which was passed by Congress in March 2020 in response to the COVID-19 pandemic.
The stimulus payments were sent to people who filed taxes for the 2019 tax year. The amount of the payment depended on several factors, including income and family size. In addition to the stimulus payments, the Economic Security Act also included provisions for emergency rental assistance and extended unemployment benefits.
The goal of the Economic Security Act was to provide a much-needed boost to the economy during a time of crisis. And while the jury is still out on whether or not it was successful in achieving that goal, it’s clear that the act had a significant impact on the lives of many Americans.
Purpose of Economic Stimulus
The idea of economic stimulus was first introduced by 20th-century economist John Maynard Keynes and further developed by his student Richard Kahn through the fiscal multiplier concept.
Keynesian economics is based on the idea that in times of economic downturn, the government can step in and help to spur economic activity through Expansionary fiscal policy. This is done by either increasing government spending or decreasing taxes which will free up more money for consumers to spend, thereby helping to stimulate the economy.
Some economists argue that Keynesian economics is no longer relevant in today’s globalized economy. Others argue that while Keynesian economics may need to be updated for the 21st century, the basic principles are still sound and can be effective if properly implemented.
How Economic Stimulus Works
There are two main types of economic stimulus: monetary policy and fiscal policy.
Monetary policy is when the government manipulates the money supply to influence economic activity. This can be done through actions such as quantitative easing, which is when the central bank creates new money and uses it to purchase assets from commercial banks to increase the amount of liquidity in the banking system.
Fiscal policy is when the government changes taxation and spending levels to influence economic activity. This can be done by either increasing government spending on infrastructure projects or decreasing taxes, which will free up more money for consumers to spend.
The effectiveness of an economic stimulus depends on several factors, such as the state of the economy at the time the stimulus is implemented, the design of the stimulus package, and how well the stimulus is executed.
Potential Risks of Economic Stimulus Spending
While many economists argue that economic stimulus can be effective in jumpstarting the economy, there are also potential risks associated with stimulus spending.
One of the main risks is that the stimulus package may not be well-designed and may end up being ineffective. Another risk is that the government may not have the fiscal capacity to implement a stimulus package, or that the stimulus package may be too small to have a significant impact.
Another risk is that the stimulus package may be inflationary if it increases the money supply too much, which can lead to higher prices and lower purchasing power for consumers. Finally, there is the risk that the government may become reliant on stimulus spending to prop up the economy, which can lead to unsustainable levels of debt.
Despite these risks, many economists believe that the potential benefits of economic stimulus outweigh the risks, and that stimulus spending can be an effective tool for jumpstarting the economy. Let us have a look at some of the counter-arguments to the economic stimulus theory-
1. Ricardian equivalence and crowding out
The Ricardian equivalence is an economic theory that suggests that taxpayers understand that government borrowing must be repaid through future taxes. As a result, they save in anticipation of these future tax increases, which offsets the stimulative effect of government spending.
The crowding out effect is when increased government borrowing crowds out private investment, leading to lower economic growth.
2. Time lags
There can be a significant time lag between when the stimulus is implemented and when it actually has an impact on the economy.
This is because it takes time for businesses to invest the money, and for consumers to spend the extra money in their pockets.
As a result, the stimulus may not have its intended effect until after the economy has already begun to recover.
3. Preventing economic adjustment and recovery
The economic stimulus can sometimes prevent the economy from adjusting and recovering on its own.
For example, if the government implements a stimulus package to prop up the housing market, it may delay the adjustment of housing prices to their true levels, which could lead to further economic problems down the road.
How to Implement an Economic Stimulus?
If the government wants to implement an economic stimulus, there are a few different ways to do so. The first is through monetary policy, which as we mentioned earlier, is when the government manipulates the money supply to influence economic activity.
The second is through fiscal policy, which is when the government changes taxation and spending levels to influence economic activity. And finally, the government can also provide direct assistance to businesses and consumers through programs like tax rebates or subsidies.
The treasury department is the executive agency responsible for promoting economic prosperity and ensuring the financial security of the United States. The Treasury Department works with financial institutions, households, and businesses to ensure that the economy is strong and prosperous.
One of the ways the Treasury Department stimulates the economy is through tax returns. Stimulus checks are often sent out to small businesses and households to promote spending and economic growth. The Economic Stimulus is an important part of the government’s efforts to promote economic growth and stability.
Example of Economic Stimulus – US Government Covid-19 Economic Stimulus Relief
Covid-19 Impact on the US Economy
The spread of Covid-19 has had a major influence on the American economy. The virus has resulted in widespread closures of enterprises and institutions, resulting in a significant rise in unemployment.
The worldwide pandemic began in June 2019, and it triggered a recession in the United States in February 2020. In March 2020, the COVID-19 crisis pushed the U.S. stock market into a bear market, with the S& P 500 not recovering to pre-pandemic highs until June 2020.
U.S. unemployment rates reached a peak of 14.7% in April 2020, which was the highest since the Great Depression—a significant increase from 3.5% just 2 months prior in February 2022. The unemployment rate sat at a steady 3.5% in August of 2020. However, the national economy fell by a surprising 3.5%, as saw inflation-adjusted growth (or gross domestic product) dipped below zero for the first time since 2009.
Economic Stimulus used by U.S. Monetary Policy
The Economic Stimulus is a credit that can be claimed on your tax return if you were eligible for stimulus checks, unemployment insurance, or other direct payments from the government in 2020. This credit is designed to help offset the financial burden of the pandemic and provide some relief to taxpayers.
There are three categories of the Fed’s stimulus measures can be divided into interest rate cuts, loans & asset purchases, and regulation changes.
1. Interest rate cuts
The Federal Reserve reduced its target interest rate, the federal funds rate, twice in March 2020—first by 0.50 percent and later by 1%. The federal funds rate, which is a range expressed as a percentage, was lowered from 1.50% to 1.75% ?to 0.00% to 0.25%. This is considerable because the Fed hasn’t moved interest rates in increments greater than 0.25%, especially since they were cut during times of recession.
The Fed reduced its discount rate, another important interest rate, by 1.5 percentage points on March 15, 2020, to 0.25%. Since the pandemic started, the target Fed rate had remained at rock-bottom levels. The Fed made three increases to the target rate since then:
- March 2022: 25 basis points in 0.25% to 0.5% range
- May 2022: 50 basis points in 0.75% to 1% range
- June 2022: 75 basis points in 1.5% to 1.75% range
- July 2022: 75 basis points in the 2.25% to 2.5% range
2. Loans and asset purchases
The Federal Reserve’s lending facilities were created in March 2020 to help support important markets and the economy during the pandemic.
The loans and asset purchases cover both quantitative easing (QE) general purchases and repurchase operations, as well as specific lines of credit that the Fed creates and programs where the Fed establishes special purpose vehicles (SPVs).
To prevent another liquidity crisis in the United States similar to the one experienced during the Great Recession, the Federal Reserve devised a plan where would extend loans to special purpose vehicles (SPVs). These SPVs would then use that money to purchase assets, essentially jumpstarting trade and commerce.
3. Asset-purchasing programs
The Fed’s asset-purchasing strategy during the epidemic is comparable to those used throughout the Great Recession.
The QE program, in which the Fed buys assets such as US Treasuries and mortgage-backed securities (MBS), is one of the simplest asset-purchasing programs. The Fed commenced this program during the Great Recession and restarted it on March 15th, 2020. There was no set limit to how much the Fed would spend on these assets, with only a statement saying that they would buy “in the amounts needed to support the smooth functioning of markets.”
In January 2021, the Federal Reserve began to taper asset purchases. On December 15, 2021, Chairman Jerome Powell of the FRB announced that the Federal Open Market Committee (FOMC) had voted to speed up the reduction of net new bond purchases in response to a strengthening economy and rising inflation. The monthly purchases had reached $120 billion.
The Fed also dramatically expanded its repo operations on March 12, 2020, by $1.5 trillion, then added another $500 billion four days later—to ensure enough liquidity in the money markets. Repo operations act as loans from the Fed to banks by purchasing Treasuries from them and selling them back at a future date.
The Fed started several new lending programs in addition to purchasing assets directly. These were established as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The funds for these initiatives come from the U.S treasury.
The Fed used $1.25 billion from the Federal Reserve’s Exchange Stabilization Fund (ESF) as seed capital and did so entirely on its own. A number of SPVs were established, separate legal entities that let the Fed provide financing in ways it couldn’t otherwise do. All of these initiatives have now been discontinued.
U.S. Fiscal Policy
The United States government has passed three major relief packages and one supplementary package in March and April 2020. After the passage of “stimulus phase 3.5” in April, which was dubbed “stimulus phase 3.6,” there was little movement on COVID-19 stimulus or assistance from Congress for several months, as each political party put forth its own stimulus plan.
The $3 trillion HEROES Act, which was passed by the Democratic-controlled House of Representatives in May 2020, has yet to be approved by the Republican Senate majority. In July 2020, however, the Republicans proposed—but did not pass—the $1 trillion HEALS Act.
House Democrats offered to meet in the middle at $2 trillion, yet Senate Republicans refused and remained firm at their original proposed amount–significantly less. In December 2020, the Consolidated Appropriations Act (CAA) was passed by Congress and included a stimulus bill of $900 billion to provide additional help during this time of crisis.
During the epidemic, then-President Donald Trump and now-President Joseph Biden issued a slew of executive actions to provide assistance. Various executive branch agencies have also taken action. On March 11, 2021, President Biden signed the $1.9 trillion American Rescue Plan Act, which was a fifth major stimulus package.
In the end, the Economic Stimulus is vital in helping to stabilize the economy and prevent a complete collapse. It is also clear that there are still some lingering effects of the Great Recession, and that more needs to be done to fully recover.
Nevertheless, the Economic Stimulus was an important step in the right direction, and it is hoped that it will continue to have a positive impact on the economy in the years to come. Recovery rebate credit, federal taxes, unemployment insurance, stimulus checks, direct payments, and partial payments are all key components in the Economic Stimulus package that aim to help those who have been most affected by the Great Recession.
While it is impossible to know exactly how effective the Economic Stimulus will be in the long term, it is clear that it has already had a positive impact on the economy and on the lives of many Americans.
Do you think stimulus payments are a good way to jump-start the economy? Do you think the Economic Security Act was successful in its goals? Share your thoughts in the comments!