Stimulus (economics)

Typical intervention strategies under different conditions

In economics, stimulus refers to attempts to use monetary or fiscal policy (or stabilization policy in general) to stimulate the economy. Stimulus can also refer to monetary policies like lowering interest rates and quantitative easing.^[1]

A stimulus is sometimes colloquially referred to as "priming the pump" or "pump priming",^[2] In the 1930s, President Herbert Hoover was accused of "pump priming",^[3] and President Franklin D. Roosevelt used the term favorably.^[4]

Concept

Often, the underlying assumption is that, due to a recession, production and employment are far below their sustainable potential (see NAIRU) due to lack of demand. It is hoped that this will be corrected by increasing demand and that any adverse side effects from stimulus will be mild.

Fiscal stimulus refers to increasing government consumption or transfers or lowering taxes. Effectively this means increasing the rate of growth of public debt, except that particularly Keynesians often assume that the stimulus will cause sufficient economic growth to fill that gap partially or completely. See multiplier (economics).

Monetary stimulus refers to lowering interest rates, quantitative easing, or other ways of increasing the amount of money or credit.

Economist views

Milton Friedman argued that the Great Depression was caused by the fact that the Federal Reserve did not counteract the sudden reduction of money stock and velocity. Ben Bernanke argued, instead, that the problem was lack of credit, not lack of money, and hence, during the financial crisis, the Federal Reserve led by Bernanke provided additional credit, not additional liquidity (money), to stimulate the economy back on trail. Jeff Hummel has analyzed^[5] the different implications of these two conflicting explanations. President of the Federal Reserve Bank of Richmond, Jeffrey Lacker, with Renee Haltom, has criticized^[6] Bernanke's solution because "it encourages excessive risk-taking and contributes to financial instability." ^[7]

It is often argued that fiscal stimulus typically increases inflation, and hence must be counteracted by a typical central bank. Hence only monetary stimulus could work. Counter-arguments say that if the output gap is high enough, the risk of inflation is low, or that in depressions inflation is too low but central banks are not able to achieve the required inflation rate without fiscal stimulus by the government.

Monetary stimulus is often considered more neutral: decreasing interest rates make additional investments profitable, but yet only the most additional investments, whereas fiscal stimulus where the government decides the investments may lead to populism or corruption. On the other hand, the government can also take externalities into account, such as how new roads or railways benefit users that do not pay for them, and choose investments that are even more beneficial although not profitable.

Typically Keynesians are particularly strongly pro-stimulus, Austrians and Rational expectations economists against, and mainstream economists between the two.

See also

• Gross fixed capital formation#Economic analysis
• Policy mix
• Stimulus bill (disambiguation)

References