Fiscal stimulus: What is it and how does it work?

Updated : February 08, 2021 06:31 PM IST

A stimulus package provides tax rebates and boosts spending.

Fiscal stimulus is used by govt to stimulate economy and prevent the country from a financial crisis

A fiscal stimulus is a package comprising tax rebates and incentives. It's used by the government to stimulate the economy and prevent the country from a financial crisis.

A stimulus package provides tax rebates and boosts spending. As spending increases demand, it creates a situation where employment rises. This, in turn, leads to a rise in income, which proportionately boosts spending. As this continues, the economy recovers from collapse.

In 2008, at the time of the global financial crisis, the United States had provided a fiscal stimulus that was aimed at increasing the employment rate and boosting the economy. In 2008, India too, used the country’s first stimulus package to ensure the safety of bank deposits and stability of the financial system.

In recent memory, last week, US President Joe Biden proposed a $1.9 trillion stimulus package, to help the economy recover from the after-effects of the coronavirus pandemic. The proposed package includes more aid for the jobless and poor, additional support for small businesses, states and local governments and increased funding for COVID-19 vaccinations and testing.

How does a stimulus package work?

A financial crisis can begin in many ways, a pandemic like COVID-19 being one. No matter how it starts, the most effective way to overcome the crisis is by infusing plenty of money into the economy. A fiscal stimulus is one of the prescriptions of infusing money into an economy that's going through a crisis. The government hands over the money, via direct subsidies, loans, or tax incentives, to individuals, companies and entire industries, to bail them out of the crisis.

Among the most common fiscal stimulus are industry bailouts. During the 2008 recession, the Indian government infused liquidity into the banking system. The Reserve Bank of India (RBI) reduced the CRR and repo and reverse repo rates. These measures were taken to stimulate the Indian economy.

The second form of stimulus is tax incentives and rebates. Cutting certain taxes or providing rebates is a common component of stimulus packages. The aim of tax incentives is to leave more money in the hands of businesses or individuals. The government hopes that individuals and companies spend the extra money, thereby, boosting more economic activity.

Stimulus packages in India last year

On March 26, 2020, India announced its first economic stimulus package worth Rs 20.97 lakh crore to help millions of low-income households cope with a coronavirus-induced lockdown.

On October 12, 2020, the Finance Ministry introduced a second set of measures to spur consumer spending and bolster demand in the coronavirus-hit economy and announced a package of Rs 73,000 crore. In the quarter ending June 2020, the Indian economy was the worst-performing major economy, contracting at 23.9 percent amid the stringent lockdown. A few years ago, the International Monetary Fund had singled out the Indian economy as a global bright.

On November 12, 2020, the government announced a third economic package of Rs 2.65 lakh crore to stimulate the economy by creating jobs and boosting consumer demand, manufacturing, agriculture and exports hit by the pandemic.

Published : February 08, 2021 06:31 PM IST

Fiscal stimulus: What is it and how does it work?

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