The economic stimulus can be defined as the actions, based on the Keynesian Economics ideas, taken by the government to motivate the private sector economic activity by engaging in expansionary fiscal or monetary policy.
This term is based on the similarity of a stimulus and the response biological process, with an objective of using government policy in the form of a stimulus to get a response from the Economy of the private sector.
Commonly, this methodology is applied during the time of Recession. The policy tools that are often used are increasing government spending, decreasing interest rates, and easing quantitative measure amidst others.
According to Keynesian economics, the concept of recession is a tenacious deficiency of aggregate demand, wherein the economy doesn’t correct itself, but rather reach a new equilibrium at a lower output, higher unemployment rate, and slower growth.
As per this theory, to fight recession, the government must implement expansionary fiscal policy so as to make up for deficits in the private sector consumption to restore full employment and total demand.
Fiscal stimulus is different from fiscal policy and expansionary money as it is a completely conservative and targeted approach to policy. Therefore, rather than using fiscal or monetary policy to replace the spending of the private sector, economic stimulus helps to direct government deficit spending, new credit creation, lowered interest rates, and tax cuts toward certain primary sectors of the economy.
This makes it easier to avail the advantages of the multiplier effect that indirectly increase investment spending and the consumption of the private sector. Thus, increased private sector spending will boost the economy and get it out of recession.
The primary objective of economic stimulus is to acquire a stimulus-response effect so as to make the economy of the private sector to do the most to combat the recession and avert several risks that may come along with extreme monetary policy or huge government deficits.
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These risks may comprise nationalization of industry, government defaults, or hyperinflation. By boosting the growth of the private sector, stimulus deficit spending could pay for itself via high tax revenues; thus, resulting in quicker growth.