Economic stimulus is a government policy that aims to raise demand in the economy by reducing taxes or increasing spending. It should be timely, temporary, and well targeted. It should be timely, so that its effects are felt while economic activity is below potential; otherwise it could cause a rise in prices (known as inflation). It should be temporary, to avoid raising interest rates and to minimize the adverse long-run impact of a larger budget deficit. And it should be well targeted, to provide resources to those most likely to spend them. This reduces the risk of crowding out – that higher government spending will lead to an equivalent fall in private sector spending.
In the United States, economic stimulus policies typically involve tax cuts for businesses and households. The theory behind these is that individuals are likely to spend any additional money they have at their disposal, and so when governments lower taxes, this frees up more income for people. This increases demand, which helps to boost production and employment. This cycle can help to pull an economy out of a recession.
The most effective types of fiscal stimulus, according to Keynesians, are those that go to low and middle-income households – because these groups have the highest marginal propensity to consume. Recent research suggests that timing household rebates around the holiday shopping season may increase their effectiveness, as it seems to reduce the likelihood of people socking the funds away in savings.