Economic stimulus is a policy the government uses to encourage the economy to grow. It typically involves increasing spending and taxes, but can also include scrapping regulations to make it easier for businesses to do business. In the case of a severe economic downturn, this can be very effective in reviving the economy.
The idea behind economic stimulus stems from theories developed by the economist John Maynard Keynes. Keynes argued that the economy goes through cycles of high and low economic growth. When the economy is high, there is more demand for goods and services, so companies hire workers. This creates more jobs and more spending, creating a virtuous cycle of economic growth. However, when the economy is low, there is less demand for goods and services, so companies cut back on hiring workers and consumers spend less. This cuts into company revenues and causes the economy to slow down, or enter a recession.
In order for a fiscal stimulus to be effective, it should be well-targeted. Ideally, it should go to households or businesses most likely to raise spending in response to the stimulus and thus boost gross domestic product in the short run. This includes those groups that have a higher marginal propensity to consume, such as lower-income families, who tend to spend all their income. It also includes business investment incentives like bonus depreciation, which entice companies to invest more quickly.
A temporary increase in food stamp payments would be a good example of targeted fiscal stimulus. These increases are much more cost-effective than most other forms of stimulus, because they would go to people who already have the highest marginal propensity to consume and because they can be injected into the economy relatively quickly.
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