When COVID-19 began rapidly spreading across the United States, fear of a recession caused a market panic. The government took the necessary economic actions to prevent a recession and ensure financial stability. These economic actions are known as the government's stimulus packages during economic downturns.
These stimulus packages ensure that all individuals, including you, are protected during economic hardships. Most likely, you know someone who lost their job during the COVID-19 crisis and continued to get paid by the government. There are many other ways you or people you know benefited from stimulus packages.
Why don't you read on and find out how stimulus packages are used to boost the economy and how you can use them in case a recession hits the economy?
Stimulus Package Definition
A stimulus package is defined as a collection of economic actions taken by the state to boost a sinking economy. The goal is to stimulate the economy and avert or overcome a recession by increasing employment and expenditure. The first quick reaction of most governments in economic distress is to develop emergency strategies to avert economic spirals, with an emphasis on preventing lower prices from triggering continuously decreasing production and demand.
A stimulus package is a collection of economic actions taken by the government to stimulate the economy.
Generally, most countries adopt stimulus packages comprising government spending and tax cuts to stimulate their own economies. Although fiscal policy varies by country, most strive to stick to a 2% GDP target, which is mostly funded via deficit spending (public debt and loans from federal banking institutions). The effectiveness of these stimuli varies by nation.
Government Stimulus Package
Government stimulus packages refer to a set of economic measures the government undertakes when the economy is going through a recessionary period. The government stimulus packages are intended to boost economic growth and limit the impact a recession might have on the economy.
In addition, a government stimulus package is also used as a preventative measure against a recession.
In response to the Great Recession in 2009, the United States government implemented a stimulus known as The American Recovery and Reinvestment Act of 2009 (ARRA), or simply the Recovery Act. The ARRA was implemented to reduce the Great Recession's impact, which started in 2008. Some of the main goals of this stimulus package were to keep the unemployment rate under control, invest in infrastructure, and provide short-term assistance programs for individuals most severely impacted by the recession.1
In response to the Covid-19 crisis, the United States government has implemented various stimulus packages. One such stimulus package included a $1,400 check per person to boost economic growth via providing spending incentives.2
There are many possible ways government stimulus packages could be implemented, including fiscal stimulus packages and unemployment benefits packages.
Fiscal Stimulus Package
A fiscal stimulus package occurs when a government either raises the amount of money it spends or reduces the amount it collects in taxes to stimulate economic development. Fiscal stimulus packages are implemented in recessionary periods to boost economic growth.
Fiscal stimulus is a type of expansionary fiscal policy that is conducted by either increasing government spending or lowering taxes.
In many cases, the effects of fiscal stimulus (particularly the expenditure component) are intended to be temporary, yet the advantages of these policies may persist for decades.
For example, the construction of a bridge today by the government results in the immediate employment of individuals. It will also assist in the transportation of products for many decades.
The government uses two main tools when conducting fiscal stimulus: increasing government spending or lowering taxes.
Fiscal stimulus package: Increase in government spending
An increase in government spending is done in recessionary periods to boost economic growth. The increase in government spending can be in many forms, such as building new highways, hospitals, schools, etc.
Let's consider what happens when the government increases its spending to boost economic growth. Let's imagine the economy is going through a recession, and the unemployment rate has skyrocketed. The government needs to step in and take action.
The government decides to build a hospital. In constructing the hospital, the government employs many individuals to do the construction work, contributing to a decrease in the unemployment rate.
These individuals who weren't receiving income until the hospital building started consuming more. This contributes to an increase in the aggregate demand in the economy through the fiscal multiplier.
We've covered the fiscal multiplier in detail.
Check it out to learn how government spending affects economic growth in more detail!
Fig. 1 - Effect of an increase in government spending
Using the AD-AS model in Figure 1, we can illustrate the impact that the increase in government spending on building the hospital has on the economy. As a result of the increase in aggregate demand from the money spent on building the hospital, the aggregate demand curve shifts to the right from AD1 to AD2. The shift in aggregate demand increases the total output produced in the economy from Y1 to Yp, and the price level from P1 to P2.
Fiscal stimulus package: Tax reduction
In addition to an increase in government spending, the government may also decide to reduce taxes individuals pay on their income as part of a fiscal stimulus.
When individuals pay fewer taxes, they have more money available to use for the consumption of goods and services, which causes the overall demand in the economy to increase.
Increasing overall demand for goods and services incentivizes businesses to produce more. As more production occurs, more people are employed to meet the rise in demand, helping reduce the unemployment rate in the economy.
The overall impact of tax reduction is the higher output produced and lower unemployment rate.
Unemployment Benefits Stimulus Package
The unemployment benefits stimulus package is intended for individuals who lose their jobs for various reasons. When an individual loses their job for various reasons, usually reasons beyond their control, the government substitutes their income in the form of unemployment benefits. In other words, they receive government payment until they find a new job.
The unemployment benefit stimulus package is income the government provides to individuals who lose their jobs.
The purpose of unemployment benefits is to provide individuals who have lost their job with the necessary financial means they need to continue their search for another job. The income provided by the government is usually enough to cover the daily expenses of an individual.
However, there are specific criteria that one should meet to be eligible for unemployment benefits. The requirements to qualify for unemployment benefits vary from country to country.
For example, in the United States, for an individual to be eligible for unemployment benefits, they must have worked during a specified period, in most cases up to 18 months. The individual must have earned a minimum wage, which is determined by the state of their living, and should be actively looking for a job whilst collecting unemployment benefits. Additionally, the individual has to prove they were laid off for reasons beyond their control.3
The amount of money received from unemployment benefits is a percentage of the applicant's former income. State governments are usually the ones that fund unemployment benefits.
Negative Effects of Stimulus Package
While government aid can be beneficial, there are negative effects of stimulus packages. When the government injects a significant amount of money into the economy through fiscal stimulus, it can harm individuals and businesses. We've includes the main negative effects of stimulus package in Figure 2.
One of the first negative effects of stimulus packages is the increase in inflation that follows as a result. Fiscal stimulus has a direct impact on aggregate demand either through lowering taxes or increasing government spending. When the government injects money into the economy, it causes everyone to consume more.
Think about it, if the taxes you pay are lowered, you would most likely respond by buying more goods and services. When this happens on an aggregate level, and everyone starts to consume more, it causes the overall prices to rise.
Research shows that when the government provides stimulus packages, colleges either reduce the amount of help they provide to students, raise tuition and fees, or do all of the above. As a result, many students and families from middle-class backgrounds are forced to take on debt to pay for education.4
Another negative effect of stimulus packages is the crowding-out effect.
The crowding out is an economic phenomenon that occurs when increasing government spending causes private investment spending to decrease.
The government has to increase its spending when providing fiscal stimulus. However, this spending is financed by a decrease in national savings, which drives the economy's interest rate up. The rise in the interest rate causes a decrease in investment spending in the economy as the cost of borrowing increases.
- Private investment spending is an essential component of a thriving economy. When there is less investment, there are fewer possibilities for new firms to start up, for existing businesses to grow, for people to get jobs, and for innovation to occur.
Another adverse effect of a stimulus package is the decline in productivity and motivation to work. Transfers of money and goods, known as in-kind and cash transfers, lower the motivation to work. When provided with a stimulus package, individuals would prefer to stay at home rather than go to work while earning a similar amount of money. This then hinders economic growth as there is less output produced in the economy.
Stimulus Package - Key takeaways
- A stimulus package is a collection of economic actions taken by the government to stimulate the economy.
- Fiscal stimulus is a type of expansionary fiscal policy that is conducted by either increasing government spending or lowering taxes.
- The unemployment benefit stimulus package is income the government provides to individuals who lose their jobs.
- The crowding out is an economic phenomenon that occurs when increasing government spending causes private investment spending to decrease.
References
- Congress.gov, American Recovery and Reinvestment Act of 2009, https://www.congress.gov/bill/111th-congress/house-bill/1/text
- White House, American Rescue Plan, https://www.whitehouse.gov/american-rescue-plan/
- Benefits.gov, Unemployment Insurance, https://www.benefits.gov/benefit/91#:~:text=Unemployed%20through%20no%20fault%20of%20your%20own%2C%20and,week%20you%20are%20collecting%20benefits.
- Veronique de Rugy and Jack Salmon, Reevaluating the Effects of Federal Financing in Higher Education, https://www.mercatus.org/publications/education-policy/reevaluating-effects-federal-financing-higher-education
- Benefits.gov, Unemployment Insurance, https://www.benefits.gov/benefit/91#:~:text=Unemployed%20through%20no%20fault%20of%20your%20own%2C%20and,week%20you%20are%20collecting%20benefits.
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