RebelCapitalist: Financial Information for the Rest of Us

What is “Stimulus”?

Jul 09, 2009 | By: Mr_Blue | Tags: economic stimulus, fiscal policy

In the last few days there has been talk about a second “economic stimulus plan”. There is a lot of disagreement about whether a second stimulus plan is needed. Putting the debate aside, what exactly is an “economic stimulus plan” that politicians and economists refer to?

An “economic stimulus plan” refers to the changes in fiscal policy - taxes and government spending - that try to spur economic growth. Recently, economic stimulus has taken several forms most notably “tax rebates” and direct government spending. The different forms of stimulus have different impacts on the economy and different timing. No form of economic stimulus will guarantee economic growth.

“Tax rebates”, or “stimulus checks” as they were called, are basically a cash advance on a person’s potential tax return. Tax rebates have to be claimed as income on tax returns for the year received. The theories behind “tax rebates” are that 1) individuals, as consumers, are better able to spend the money than the government; and 2) rebates will give an immediate jolt to the economy through increased consumer spending.

The problem with tax rebates has been that individuals, as consumers, have been so overwhelmed by debt that instead of spending the “tax rebates” on consumer goods most of the “stimulus check” goes to paying bills or debt. As a result, “tax rebates” have had very limited impact on economic growth. Any impact is also very temporary.

Recently, direct government spending has taken mainly two forms: 1) extended funding for unemployment compensation; and 2) infrastructure investments such as roads and schools. The infrastructure investment portion hopes to create jobs related to the public projects. The theory is that this job creation will “grow the economy” because working people will have money to spend. The challenge for this type of government spending is that it takes time because of the bureaucratic process for public projects.

“Tax rebates” or direct government spending are both temporary measures that try to limit the full impact of a recession (or in our case a deep recession). Our current economic problems are deep and severe meaning that any form of “economic stimulus” should be huge to have any significantly positive impact on our economy. However, the size of any “economic stimulus” is limited by financial condition of the U.S. government mainly huge budget deficit and huge amount of federal debt and politics.