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In economics,stimulus refers to attempts to usemonetary policy orfiscal policy (orstabilization policy in general) tostimulate the economy. Stimulus can also refer to monetarypolicies such as lowering interest rates andquantitative easing.[1]
A stimulus is sometimes colloquially referred to as "priming the pump" or "pump priming".[2]
During arecession, production andemployment are far below their sustainable potential due to lack ofdemand. It is hoped that increasing demand will stimulate growth and that any adverse side effects from stimulus will be mild.
Fiscal stimulus refers to increasing government consumption or transfers or lowering taxes, increasing the rate of growth ofpublic debt. Supporters ofKeynesian economics assume the stimulus will cause sufficienteconomic growth to fill that gap partially or completely via themultiplier effect.
Monetary stimulus refers to lowering interest rates,quantitative easing, or other ways of increasing the amount of money or credit.
Milton Friedman argued that theGreat Depression was caused by the fact that theFederal Reserve did not counteract the sudden reduction of money stock and velocity.Ben Bernanke argued, instead, that the problem was lack ofcredit, not lack of money, and hence, during theGreat Recession, theFederal Reserve led by Bernanke provided additional credit, not additional liquidity (money), to stimulate the economy back on course. Jeff Hummel has analyzed the different implications of these two conflicting explanations.[3] President of theFederal Reserve Bank of Richmond,Jeffrey M. Lacker, with Renee Haltom, has criticized Bernanke's solution because "it encourages excessive risk-taking and contributes to financial instability."[4]Thomas M. Humphrey andRichard Timberlake concentrated in their book "Gold, the Real Bills Doctrine, and the Fed: Sources of Monetary Disorder 1922–1938" on thereal bills doctrine as a causative factor in theGreat Depression.[5]
It is often argued that fiscal stimulus typically increasesinflation, and hence must be counteracted by a typical central bank. Hence only monetary stimulus could work. Counter-arguments say that if theoutput 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 additionalinvestments profitable, but yet only the most additional investments, whereas fiscal stimulus where the government decides the investments may lead topopulism viapublic choice theory, orcorruption. However, the government can also takeexternalities into account, such as how new roads or railways benefit users who do not pay for them, and choose investments that are even more beneficial although not profitable.
Supporters ofKeynesian economics are typically strongly in favor of stimulus.Austrian economic school andRational expectations economists are typically against stimulus.
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