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Fiscal policy uses two tools. What are they?
Government spending and taxation.
So what is a fiscal stimulus?
When the government increases spending or cuts taxes to raise demand, usually in a recession.
Which parts of aggregate demand does it affect?
Spending adds to G directly, and tax cuts raise consumption and investment.
Good. On an AD/AS diagram, which way does the AD curve move?
To the right, so output rises and unemployment falls.
If people spend 75 per cent of any extra income, what is the multiplier?
One divided by 0.25, which is 4.
So what could USD 50 billion of extra spending do to national income?
Raise it by up to USD 200 billion, though less in reality because of saving, taxes and imports.
Now the cost. Revenue is USD 400 billion and spending USD 450 billion. After USD 30 billion more spending and a USD 10 billion tax cut, what is the deficit?
Spending is USD 480 billion and revenue USD 390 billion, so the deficit is USD 90 billion.
Exactly. Stimulus is not free; it is usually paid for by borrowing.
India announced a package worth about ₹20 lakh crore in May 2020. Was all of that new government spending?
No. Much of it was loans, credit guarantees and Reserve Bank liquidity, so the direct budget cost was smaller.
Who were the main winners?
Small businesses that got collateral-free loans, and rural workers through extra money for MGNREGA.
And the cost?
The fiscal deficit rose sharply, so debt and future interest payments went up.
So a fair evaluation weighs short-term relief against long-term debt.
Raising government spending or cutting taxes to increase aggregate demand.
Each round of spending creates income for others, so national income can rise by more than the first injection.
A stimulus can end a slump, create jobs, help the hardest-hit groups and build infrastructure.
Deficits, debt, inflation near full capacity, time lags and crowding out.
Judge a stimulus by its size, timing, targeting, winners and losers, and long-term costs.
India 2020: The Atmanirbhar Bharat package had a headline value of about ₹20 lakh crore, but much of it was loans and guarantees rather than direct spending.
United States 2020: The CARES Act, worth about USD 2.2 trillion, sent payments to households and supported businesses during the pandemic.
Multiplier sum: With an MPC of 0.75, the multiplier is 4, so USD 50 billion of new spending could raise national income by up to USD 200 billion.
Spend more, tax less, lift demand from its distress; but borrow too long and debt will press.
A town's factory closes and shops empty out. The council hires workers to repair the roads. They buy lunch at the cafe, the cafe owner buys new chairs, the carpenter takes on an apprentice. One project starts many rounds of spending, but the council must repay its loan.
G up or T down, AD goes to town.
D.I.L.C. - Debt, Inflation, Lags, Crowding out: the four main risks of stimulus.
Term
What is a fiscal stimulus?
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Term
What is the formula for the simple multiplier?
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Why can a stimulus cause inflation?
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What is crowding out?
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Name two disadvantages of fiscal stimulus besides inflation.
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The use of government spending and taxation to influence the economy.
An increase in government spending, a cut in taxes, or both, to raise aggregate demand.
Total spending in an economy: consumption, investment, government spending and net exports.
The process by which an initial injection of spending leads to a larger final increase in national income.
The fraction of each extra unit of income that people spend.
The amount by which government spending exceeds government revenue in a year.
The total amount the government has borrowed and not yet repaid.
A fall in private investment caused when government borrowing pushes up interest rates.
A fiscal stimulus is an increase in government spending or a cut in taxes designed to raise total demand when an economy slows down. It can restore growth and jobs, but it also enlarges budget deficits and debt and, if used when the economy is already near full capacity, can cause inflation.
Fiscal policy is the use of government spending and taxation to influence the economy, and a fiscal stimulus is its expansionary form. Extra government spending adds directly to aggregate demand, while tax cuts raise households' and firms' spending power; through the multiplier effect, the final rise in national income can be larger than the first injection. Stimulus can lift demand in a recession, reduce unemployment, support vulnerable groups and, if spent on infrastructure, add to future capacity. Its drawbacks include larger deficits and national debt, inflation if overused, time lags, possible crowding out of private investment and the political difficulty of reversing it. Examples such as India's 2020 COVID-19 packages show how to evaluate a stimulus by its size, timing, targeting, winners and losers, and long-term costs.
When an economy slows down, a government can use its budget to support demand. This lesson defines fiscal stimulus, explains how it works and shows how to evaluate it.
Fiscal policy is the use of government spending and taxation to influence economic activity. A fiscal stimulus, also called expansionary fiscal policy, means increasing government spending, cutting taxes, or both, in order to raise aggregate demand (AD), the total spending in an economy, usually during a slowdown or recession.
Aggregate demand is made up of consumption (C), investment (I), government spending (G) and net exports (X minus M). A stimulus works through these parts:
When AD rises, firms sell more, produce more and hire more workers, so real output rises and unemployment falls. On an AD/AS diagram, the AD curve shifts to the right.
Money spent by the government becomes income for someone else, who spends part of it, which becomes another person's income, and so on. In a simple model, the multiplier = 1 / (1 minus MPC), where MPC is the marginal propensity to consume, the fraction of extra income that people spend. If MPC = 0.75, the multiplier is 1 / 0.25 = 4, so an extra USD 50 billion of government spending could raise national income by up to USD 200 billion. In reality the effect is smaller because some income is saved, taxed or spent on imports.
In March 2020 the government announced a relief package of about ₹1.7 lakh crore under the Pradhan Mantri Garib Kalyan scheme, including free food grains and cash transfers for poor households. In May 2020 it announced the Atmanirbhar Bharat package; counting these earlier measures, its headline value was about ₹20 lakh crore, roughly 10 per cent of GDP. It included a ₹3 lakh crore Emergency Credit Line Guarantee Scheme for collateral-free loans to micro, small and medium enterprises (MSMEs) and an extra ₹40,000 crore for the rural employment guarantee scheme, MGNREGA. However, much of the headline figure consisted of loans, credit guarantees and Reserve Bank liquidity measures, so the direct cost to the budget was far smaller than ₹20 lakh crore. The support helped many small firms and rural households through the crisis, but the government's fiscal deficit rose sharply, raising concerns about debt. Other countries used much larger direct spending; the United States passed the CARES Act in March 2020, worth about USD 2.2 trillion.
Using the evaluation framework of this section, ask: Was it large enough and on time? Who gained and who lost? What was the opportunity cost of the money? Did it meet its stated goals in the short term, and what are its long-term costs?