An economic stimulus is a government policy designed to jumpstart an economy that has slowed down. It usually consists of fiscal and monetary policies and is aimed at preventing or reversing a recession.
Economic stimulus can take many forms but is generally designed to directly affect individuals or companies. The goal is to create positive knock-on effects throughout the economy that will ultimately stimulate growth.
The most common methods of economic stimulus are tax cuts and increased government spending. This is because when taxes are lowered, more money becomes available for people to spend (also known as having disposable income). Increased government spending also does the same. The theory is that these increased spending will stimulate a sluggish economy by increasing aggregate demand and increasing the amount of goods and services produced.
Stimulus can be especially effective if it is targeted to households that are most likely to raise their consumption in response to it. This is because higher-income households can typically smooth their consumption over the business cycle by using savings or borrowing, whereas lower-income households may cut back on consumption when times are tough. Hence, dollars that are given to low-income households have a greater multiplier effect on the economy than dollars that are given to high-income households.
However, critics argue that economic stimulus can actually delay a private-sector recovery from the real causes of a slowdown. For example, giving industry bailouts to failing businesses promotes irresponsible business practices and stops newer, more successful businesses from growing. Furthermore, they argue that a stimulus plan can cause sudden spikes in inflation that could decrease the relative value of assets held by consumers.