What is a Government Stimulus Package?
A government stimulus package is a series of economic measures applied by a government to stimulate a stressed economy. The stimulus package can be used to strengthen an economy that is coming out of recession by lowering tax rates or increasing government spending in attempting to lower unemployment and boost consumer spending.
Government Stimulus Package Explained
An economy that is experiencing a recession or is expected to enter a recession may cause the government to intervene by enacting a series of economic measures to dampen the impact. A country’s leaders or economic managers do so by enacting a bill with various measures in the form of a government stimulus.
In contrast to an economic stimulus package that involves coordinated monetary policy and fiscal policy, a government stimulus package comes in the form of government actions through fiscal policy only.
Fiscal policy refers to a government’s usage of additional spending and revised taxation policies to influence overall economic conditions. Unlike monetary policy, fiscal policy is not associated with a country’s central bank. Instead, it is a policy enacted only by the government, independent of the central bank. The government uses fiscal policy in the following ways:
- Increasing or decreasing government spending
- Increasing or decreasing tax rates
A government may enact the measures above in certain economic situations so that the economy does not go into recession, where growth is slow or negative. Additionally, a government may enact reverse measures in a situation where an economy is growing too fast, with inflation getting out of control.
Economic Impact of Government Stimulus Packages
An economy is in a recession when economic activities decline over a period of time. It is usually visible in a decrease in the gross domestic product (GDP). In order to combat a recession, a government and its central bank will coordinate their efforts to drive gross domestic product upwards. The components of GDP is as follows:
A government stimulus package aims to increase a country’s GDP by influencing the individual components upwards through its actions.
1. Increasing or decreasing government spending on projects
By controlling the amount of government spending on public projects, the government directly affects the “government spending” component of GDP. Furthermore, the government is able to increase employment and economic growth from their projects. In a recession, a government can increase its spending on various projects to stimulate the economy.
An example is building public transportation infrastructure, schools, hospitals, and other public projects. It will increase employment for workers on the project and spending on materials and equipment for the project. It should lead to an increase in the “consumer spending” component of GDP.
2. Increasing or decreasing tax rates
By adjusting tax rates, the government can influence the “consumer spending” component of GDP. In a recession, reduced tax rates will put more disposable income in the hands of consumers and businesses that they can use for consumption. Higher consumption leads to increased demand for goods and services.
Therefore, businesses will hire more workers to keep up with the demand for goods and services. The increase in demand for labor will lead to wage hikes, which in turn boosts consumer disposable income and consumption in a virtuous cycle.
Risks of Government Stimulus Packages
Government stimulus packages involve direct government intervention in the economy to keep people employed and spending. Although it may be necessary, it draws criticism from schools of thought that believe capitalism is optimal with as little government intervention as possible.
When enacting a large stimulus package, a government will need to take on a significant amount of debt to fund the package. High levels of debt levels lead to an increase of bankruptcy risk for a country’s government and can lead to credit downgrades in the sovereign debt of the country.
Theoretically, a government should increase taxes and decrease spending in order to pay back the debt in years of economic growth. Unfortunately, in practice, it is rarely the case, and debt levels continuously increase.
Government stimulus packages also rely on the assumption that when sich policies are enacted, people will spend their increased disposable income. However, if consumer confidence is low, people may decide to save money instead of spending money, which will not affect the economy in the way the government originally anticipates.
After the Global Financial Crisis of 2008-2009, countries around the world used government stimulus packages to boost domestic economies. The packages included large tax breaks and spending projects aimed at creating more jobs following record unemployment levels.
In March 2020, several countries put together government stimulus packages to counter the economic shutdown from the COVID-19 pandemic. The stimulus packages included financial market stabilization, mortgage payment deferrals, tax breaks, company bailouts, and emergency unemployment support.
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: