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Caffeine picks up. Start a broken car. Regardless, when the U.S. economy faces a severe downturn, it often needs a boost.
This is where economic incentives come into play. As a form of policy, economic stimulus can help provide more support during booms, or be a key antidote to getting economies through recessions. Here’s everything you need to know about economic stimulus, including what they are, why they matter and how they might affect you.
What is an economic stimulus?
Stimulus policies are policies specifically designed to stimulate the economy, either in the form of fiscal policy by lawmakers on Capitol Hill or monetary policy by Federal Reserve officials. In most cases, economic stimulus finds a way to incentivize business investment and boost private consumption.
Congress typically passes bills to pass economic stimulus measures, while the Fed can decide to lower interest rates or buy more assets, thereby lowering borrowing costs.
“Stimulus is an effort created by the government, often at the taxpayer’s expense, to stimulate more economic activity than expected,” said Mark Hamrick, senior economic analyst at Bankrate. , and with the approval of the President.”
How Economic Stimulus Works
The theory is that through tax cuts or interest rate cuts—two forms that economic stimulus often takes—businesses and households may be willing to spend to burn through excess spare change. And from a 30,000-foot perspective, these actions are putting more money in the pockets of consumers and businesses than taking it away.
For example, tax cuts reduce what households and companies have to pay the federal government. Some lawmakers also argued that the tax cuts could lead to more tax revenue through other channels, such as sales or payroll taxes, as economic growth picks up.
At the same time, lower interest rates have reduced the amount individuals have to pay to borrow money. Suppose businesses and consumers want to buy something with their extra money.
Stimulus is often “a priority in recessions, including during the Great Recession and the most recent COVID-19-related recession,” Hamrick said.
But the stimulus isn’t just for the downturn. The Federal Reserve cut interest rates three times in a row in 2019 to boost the economy as businesses faced uncertainty surrounding the U.S.-China trade war. On the other hand, the Trump administration enacted the Tax Cuts and Jobs Act in 2017. Both measures come at a time when the U.S. economy is already in its longest expansion on record.
Risks to Economic Recovery
But there are still fine print, and many lawmakers on Capitol Hill have expressed concern about spending money to get out of the downturn.
Pundits warned that inflation would rise as government spending and the money supply surged, although those fears did not materialize after Congress and the Federal Reserve responded to the Great Recession of 2007-2009. Even more surprising, inflation was lower than most Fed policymakers expected.
Since fiscal stimulus means increased government spending, taxpayers foot the bill for these measures. Tax increases are likely in the future, although most experts believe a recession is not the time to worry about them. Higher spending could also lead to higher debt-to-GDP ratios and a surge in government deficits that were already widening before the coronavirus crisis hit.
Risks also include providing Americans with additional spending that they can park amid broader economic and financial uncertainty.
purpose of economic recovery
How economic stimulus helps the economy is simple. Consumers buy products that contribute to a company’s bottom line. When more people keep spending money, it makes businesses want to expand and hire more workers. More workers employed means more money in American hands.
Fiscal stimulus would also help help households and businesses weather the emergency and prevent a wave of bankruptcies that could weigh on long-term growth.
This highlights another important purpose of stimulus, which goes beyond mere stimulation to promote growth. During times of economic uncertainty, demand typically falls, and increased government spending can help offset those declines.