A stimulus package is defined as a package of tax rebates and incentives that are used by the governments. It serves the different governments of countries in stimulating the economy and saving their country.
However, we will keep this topic on the ground on the merit and tips of this very subject.
The concept behind a stimulus package is to offer tax rebates and boost spending. As spending increases demand, which in turn, leads to an increase in the employment rate. In other words, it in turn increases income and hence boosts spending. This cycle keeps rotating until the economy recovers from collapse.
One of such stimulus packages was used by the United States in 2008. This was during the time of the global recession. However, it was geared towards increasing employment and recovery of the U.S economy.
The stimulus package was also used in India for the first time in 2008. This was to ensure the safety of bank deposits as well as the stability of the financial system. Necessary steps were taken by the government to infuse liquidity into the banking system.
Thus, in a bid to infuse liquidity into the banking system, RBI reduced the CRR and repo and reverse repo rates. Also, the problems encountered by non-banking financing companies were addressed.
These measures were taken by the government in order to counter the impact of the global recession and stimulate the Indian economy.
How Stimulus Package Work
A stimulus package can come in form of either a monetary stimulus or a fiscal stimulus or quantitative easing.
The monetary stimulus includes cutting interest rates to stimulate the economy. When interest rates are cut, there will be more incentive for people to borrow. What that then means is that cost of borrowing is reduced.
In a situation where individuals and businesses borrow more, there is more money in circulation. Again, it leads to less incentive to save, as well as more incentive to spend.
Note, however, that lowering interest rates, could have a weakening effect on the exchange rate of a country. This however will boost exports. When exports increase, more money comes into the economy, which encourages spending and stimulating the economy.
When a government, decides on fiscal stimulus, it cuts taxes or increases its spending in order to revive the economy. When taxes are cut, people will have more income at their disposal. This is also the same as the government fiscal policy. (1)
An increase in disposable income implies that people have more money to spend, which boosts demand, production, and economic growth. Anytime government increases its spending, it injects more money into the economy. However, this will decreases the unemployment rate, increases spending, and eventually, counters the impact of a recession.
Here, Quantitative easing can be said to be an expansionary monetary policy. Quantitative easing happens, when the central bank of a country purchases a large number of financial assets. An asset like bonds from commercial banks and other financial institutions.
When these assets are purchased in large amounts, it increases the excess reserves held by the financial institutions. It also facilitates lending, increases the money supply in circulation, hikes the price of bonds. It can be used to lowers the yield and lowers interest rates.
A government will usually decide on quantitative easing. This is when a conventional monetary stimulus is no longer effective.
Do Stimulus Packages Produce Inflation?
Economists, do not agree as to whether and under what circumstances stimulus packages cause inflation. Some are of the opinion that stimulus packages are inherently inflationary. Hmmm! This is still not yet proven. Though, they increase the amount of money in circulation without increasing the economy’s productive capacity.
From this school of thought, inflation is the inevitable result of more money chasing the same quantity of goods and services.
Developed economies are the United States, Canada, and Japan. On the other hand, they have always used large-scale stimulus packages in recent years and have. So far, not seen material increases in inflation. We still keep our fingers crossed.
It remains to be seen what impact these stimulus packages will have on inflation in years to come. Can the effect be managed? Is it the best? Can it be checked? The future will tell.