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What is an Economic Stimulus Package?

April 14, 2020 · 7 minute read

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What is an Economic Stimulus Package?

Click on your social media channels, turn on the television or radio, scroll through your news apps or pick up a newspaper and—no matter which source you choose—you’ll likely see or hear something about the federal stimulus package designed in response to the COVID-19 challenges.

This is an evolving situation where, even now, Congress is debating about whether additional stimulus dollars should be provided—and, if so, how much? How should the dollars be distributed? Who should oversee the distribution management?

This influx of news can be confusing. To help, here are answers to some questions people may have, including:

•   What is a stimulus package, exactly?
•   When are they created, generally speaking, and why was this one put together, in particular?
•   What major economic stimulus packages have there been in the U.S.?
•   How do they work?
•   Are there different types of them?
•   What pros and cons exist when economic stimulus is provided by the government?

In general, an economic stimulus package is assembled by the government and contains financial measures that are intended to improve, or “stimulate,” an economy that’s struggling.

In the U.S., a federal package needs to be passed by the Senate and the House of Representatives—and then the president can sign it into law.

Economic Theory Behind a Federal Stimulus Package

The foundational theory behind these economic stimulus packages—whether it’s the Roosevelt, Obama or Trump stimulus package—is one developed by a man named John Maynard Keynes in the 1930s.

Keynes was a British economist who created his theory in response to the global depression of the era. His conclusion was that, when a government lowers taxes and increases its spending, this would stimulate demand and help to get the economy out of its depressed state.

More specifically, when taxes are lowered, this helps to free up more income for people; because more is at their disposal, this is referred to as “disposable income.” People are more likely to spend some of this extra money, which helps to boost a sluggish economy.

When the government boosts its spending, this also puts more money into the economy. The hoped-for results are a decreased unemployment rate that will help to improve the overall economy.

Economic theory, of course, is much more complex than that, and so are stimulus packages. Here’s more about different forms of these economic strategies.

Three Stimulus Types

Monetary

To get a bit more nuanced, monetary stimulus is something that occurs when monetary policy is changed to boost the economy.

Monetary policy, meanwhile, is how the supply of money is influenced and interest rates managed through actions taken by a central agency. In the U.S.s, that agency is the Federal Reserve Bank.

Ways in which the Federal Reserve can use monetary policy to stimulate the economy include cutting policy rates, which in turn allows banks to loan money to consumers at lower rates; reducing the reserve requirement ratio, and buying government securities.

When the reserve requirement ratio is lowered, then banks don’t need to keep as much in reserve—which means they have more to lend, at lower interest rates, which makes it more appealing for people to borrow money and get it circulating in the economy.

Fiscal

Fiscal stimulus strategies focus on lowering taxes and/or boosting government spending. When taxes are lowered, this increases the amount of money that people have left over from a paycheck, and that money could be spent or invested.

When money is spent on a greater amount of products, this increases demand for those products—which in turn helps to reduce unemployment because companies need more employees to make and sell them.

If this process continues, then employees themselves become more in demand, which makes it more likely that they can get higher wages—which gives them even more funds to spend or invest.

When the government spends more money, this can increase employment, giving workers more money to spend, which can increase demand—and so, it is hoped, the upward cycle continues.

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Quantitative Easing

Quantitative easing (QE) is a strategy used by the Federal Reserve when there is a need for a rapid increase in the money supply in the United States and to boost the economy.

For example, on March 15, 2020, the Federal Reserve announced a $700+ billion program in response to COVID-19. In general, QE involves the Federal Reserve buying longer-term government bonds, among other assets.

Pros and Cons of Stimulus Packages

The goal of a stimulus package, based on Keynesian theory is to revive a lagging economy and to prevent or reverse a recession, where the economy is retracting rather than expanding.

This is a more immediate form of relief as the government also uses monetary, fiscal, and QE strategies to boost the overall economy.

Not everyone agrees with these types of economic strategies, and disagreement began as far back as the early 1800s, when a theory was developed by a man named David Ricardo. He believed that, if the government spent more money, consumers would in fact spend less money.

Why? Because they’d be preparing to pay higher taxes to address government deficits. This is referred to as the “Ricardian equivalence” and, although not necessarily proven, policy creators typically consider this when making decisions.

Another economic theory that runs counter to Keynesian theory is the crowding out critique. According to this thinking, when the government participates in a deficit form of spending, labor demands will rise, which leads to higher wages, which leads to lower bottom lines for businesses.

Plus, these deficits are initially funded by debt, which causes an incremental increase in interest rates. This means it would cost more for businesses to obtain financing.

Other criticisms of stimulus spending focus on the timing of when funds are allocated and that central governments can be less efficient at capital allocation, which ultimately leads to waste and a low return on spending.

Previous Economic Stimulus Legislation

Perhaps the most sweeping stimulus bill ever created in the United States was signed into law by President Franklin Delano Roosevelt on April 8, 1935.

Called the Emergency Relief Appropriation Act and designed to help people struggling under the Great Depression, Roosevelt simply called it the “Big Bill”; it is now often referred to as the “New Deal.” Five billion dollars was provided to create jobs for Americans, who in turn built roads, bridges, parks, and more.

The Works Progress Administration (WPA) came out of the New Deal, ultimately employing 11 million workers to build San Francisco’s Golden Gate Bridge, LaGuardia Airport in New York, Chicago’s Lake Shore Drive, about 100,000 other bridges, 8,000 parks, and half a million miles of roads, including highways.

Another agency, the Tennessee Valley Authority, collaborated with other agencies to build more than 20 dams, which generated electricity for millions of families in the South and West.

Additionally, there was the American Recovery and Reinvestment Act (ARRA) in 2009. This was passed into law in response to the Great Recession of 2008 and is sometimes called the “Obama stimulus” or the “stimulus package of 2009.” Its goal was to address job losses.

This Act included $787 billion in tax cuts and credits, as well as unemployment benefits for families. Dollars were also provided for infrastructure, health care, and education, and the total funding was later increased to $831 billion.

Most recently, the Coronavirus Aid, Relief and Economic Security Act, or the CARES Act, was passed by the United States Senate on March 25, 2020. On March 27, 2020, the House of Representatives passed the legislation and the President signed it into law the same day.

Investing When the Market is Down

When the market goes down, it’s natural for investors to think about selling. After all, investing is much more enjoyable when stock values go up. But, selling can often be counterproductive when the market falls.

That’s because investing is a long-term commitment and, given enough time, portfolios often recover. And, many times, it may make sense to invest at this time.

So, rather than impulsively selling off stocks, it can make sense to at least consider investing when stocks are more or less on sale. The hope with this strategy is that the market downturn is temporary and investors will therefore benefit on the upswing. Having said that, buying stock on impulse may not be the best plan, either.

What’s most important is to review reasons for investing in the first place and to then find ways to stick with the plan, given portfolio goals, long-term needs, and current financial situations.

Strategies that can help with decision making include dollar cost averaging and tax loss harvesting. The first is to regularly invest a predetermined amount of money and stick with that, even when the number of shares that amount will purchase varies.

If that amount is $200, for example, that would buy 20 shares of a mutual fund when it’s going for $10 a share. If the market dips and shares are $5, still invest the same amount—but now that investment buys 20 shares. The benefit to this approach is that it involves steady investing over time.

The second strategy, tax loss harvesting, involves selling investments with a loss as a strategy to offset other investment gains. If, for example, an investor buys $5,000 worth of a particular stock at the beginning of a year, and it’s only worth $2,500 at the end of the year, they could sell that stock; buy something similar; and then write off the $2,500 loss for tax purposes.

Meanwhile, the new investment may be one that grows in value. It can help significantly to have the advice of an investment professional when making these kinds of decisions.

No-Cost Financial Planning with SoFi Invest®

With SoFi Invest®, investors have the opportunity to chat with a financial planner at no cost to discuss their short- and long-term goals when it comes to investing.

A financial planner can help investors to build a budget to reach goals, to invest smartly and save for the future, and much more.

If an investor wants to be hands on, they have the option of using SoFi active investing; if they feel better with a hands-off approach, there’s automated investing.

Furthermore, investors can receive up-to-date news through the SoFi app, helping to keep them in the know when they make their investing decisions.

Looking to plan for the future and keep up-to-date with what’s happening now? Stay in the know with the SoFi app or talk to a financial planner at no cost.


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