The Good & Bad of Fiscal Stimulus Packages

The concept of Fiscal Stimulus Packages is essentially a Keynesian concept that states that governments, if need be can help revive the economy out of a recessionary phase. The responsibility of steering the economy need not necessarily be on the private businesses. The advantage in a slowdown that the government has over the private businesses is money: unlimited amounts of it. So does it mean that the government can keep pumping in money whenever the economy needs it? The answer to that is invariably no. We can only attempt to trace the effects that a stimulus package will have on the economy but can never be sure about it.

Stimulus packages are thought to have multiplier effects on the economy. More investment by the government means job creation. When employment rises, it means that the income of the people in the economy is rising. A rise in income leads to a rise in consumption which instigates the producers to bring more to the market. And this cycle continues. If this process works well, it instills the confidence needed to restore economic growth. But it all comes down to where this money is being spent. The economy will take the aforementioned path only if the government invests in productive activities. Spending on social welfare programs provides temporary relief to the citizens but doesn’t create any multiplier effects for the economy.

It would seem that during a recession all the government has to do is invest in employment generating activities which have inter linkages with other economic activities. So where lays the problem? The biggest concern is the cost to the exchequer. Spending on a stimulus package would be funded by additional government borrowing. The burden of that borrowing would fall on future taxpayers.

Stimulus packages are thus only a temporary adjustment procedure. The timing of the withdrawal of the stimulus is very critical. Another concern with the short term measures is that they tend to delay the reform process. If an economy needs institutional restructuring, stimulus packages revive the economy in the short run, thus postponing that essential process. Government’s action to fix short term problems often creates long term damage.

If the businesses know that they will be bailed out whenever in trouble, they will be more likely to make irresponsible choices that produce another fiscal crunch. Thus, today’s fiscal challenges can be taken by policymakers as an opportunity to restructure.

Nevertheless, in times of recession, private businesses also need to restore their faith in the economic institutions of the country. To revive faith, it becomes necessary that the government invests. When that happens, government is in a way sending the signal that it’s not all bad and if these investments help stir the economy, private corporations would also catch the hint and look at expansion plans.

 

Contributed by:

Prerna Banga

Section A, Economics

Batch of 2013-15