What’s it: An economic boomlet refers to a brief period of rapid growth in economic activity. Output increases as demand grows. In addition, households see their financial prospects strengthening due to increased employment and cheap loans.
The economic boomlet may have been caused by aggressive economic policies involving simultaneous monetary and fiscal easing. Conditions such as the Covid-19 pandemic – which has caused the economy to plunge into a trough – require the government to provide a massive stimulus package to save the economy and stimulate growth.
Factors causing the economic boomlet
Economic boomlet caused by aggressive economic policy easing. Economic stimulus encourages an increase in aggregate demand in a short time. This situation then encourages businesses to increase production and absorb more workers.
Households see their income prospects improving due to improvements in the labor market. They then increase consumption, generating more demand for goods and services. This situation eventually brought economic growth to a higher level.
Easing economic policy could be monetary easing or fiscal easing. Or, it combines the two – thereby having a significant effect on the economy.
Monetary easing can take an aggressive stance in:
- Interest rate cuts
- Quantitative easing
- Lowering the reserve requirement ratio
Meanwhile, fiscal easing can be through:
- Increase in government spending
- Tax cuts
How do these policies promote economic growth? Let’s discuss them one by one.
Interest rate cuts
The central bank lowered policy interest rates to stimulate economic activity. Interest rate cuts lower borrowing costs, encouraging households and businesses to apply for loans because they are cheaper than before.
Households use it to purchase goods financed through loans, such as autos and household furniture. Because more cheap loans are available, we expect them to take advantage of this to apply for new loans.
Meanwhile, businesses apply for loans to increase working capital to boost production to a more optimal level. They began to increase their output in response to growing demand. They buy raw materials to replenish supplies and light equipment to bring production closer to full capacity.
If the outlook for household demand continues to be strong, businesses will start investing in heavy equipment such as machinery. They can invest at lower costs due to lower interest rates.
Increased spending by households and business investment ultimately increases aggregate demand. As a result, the economy grows faster as businesses increase their output to meet demand.
On the other hand, cutting interest rates also affects household wealth and consumption. Decreased low-interest rates will increase bond prices (yields fall), increasing their wealth.
Central banks buy government securities through open market operations. When purchases are made on a large scale, we call this quantitative easing. Open market operations are normally carried out with commercial banks as counterparties.
As the central bank buys government securities, money changes hands from the central bank to the commercial banks. Now, banks have more money to lend. As a result, the money circulates into the economy through loans.
Then, every dollar lent will multiply the money supply through the money multiplier effect. As a result, more money and loans are available in the economy. In addition, interest rates also fall (the cost of borrowing money) as the money supply increases.
Lowering reserve requirement ratio
Commercial banks do not use all the deposits they receive as loans. Instead, some must be kept in reserve according to central bank policy. We refer to how much is held in reserve as reserve requirements, usually expressed as a percentage.
For example, the central bank lowers the reserve requirement ratio from 10% to 5%. Say, a bank collects USD100 in deposits. With the latest ratio, the bank should hold USD5 ($100 x 5%). The amount is lower than before USD10 ( USD100 x 10%). The bank can use the remaining USD95 as a loan.
As a result, a decreased ratio will leave the bank holding more money for each deposit received. The money will circulate into the economy. And again, every USD95 lent is doubled through the money multiplier effect.
Increase in government spending
An increase in government spending has a direct impact on aggregate demand. It can create a multiplier effect on the economy.
For example, the government allocates more infrastructure spending to build roads. The increase in spending does not only create demand for goods and services directly, such as for construction materials. But it also creates jobs and income for households.
An increase in demand for goods and services directly contributes to the rise in aggregate demand. Meanwhile, job and income creation will also encourage households to increase consumption. As a result, it can produce a strong multiplier effect – as long as the economy has spare capacity.
Tax cuts impact aggregate demand through their impact on household spending and business investment. Tax cuts give businesses more profits to keep as internal capital (retained earnings).
Likewise, tax cuts also leave households with more money because they pay less to the tax authorities. Lower taxes increase their disposable income, which can be allocated for consumption or savings.
How significantly the tax cuts impact aggregate demand depends on the money allocated to consumption. If households tend to spend it on consumption, the impact on aggregate demand will be even greater. Therefore, it will promote more robust economic growth.
When households increase their consumption, the demand for goods and services increases. The business then responds by increasing output to generate more profit. Internal capital, for example, for investment, also grows more robust as companies spend less on taxes.
Boomlet growth after the Covid-19 pandemic
How the world recovered after the Covid-19 pandemic is a good example to illustrate the economic boomlet. The pandemic has contracted economic growth in the United States and the Eurozone. Their economy plunged into a trough in 2Q2020, forcing the government to intervene by launching stimulus.
In Europe, EU leaders agreed on the Next Generation EU (NGEU) recovery package to provide additional spending of EUR750 billion in total. Meanwhile, from the fiscal side, the European Central Bank (ECB) has decided to provide monetary policy support through additional asset purchases of EUR120 billion until the end of 2020 (quantitative easing).
President Biden signed the American Rescue Plan in the United States to provide coronavirus relief at an estimated cost of USD 1.844 billion. It was another round of the stimulus package to tackle the pandemic.
Previously, the Trump administration signed up to USD868 billion as part of the Consolidated Appropriations Act of 2021. In addition, there was a USD483 billion Paycheck Protection Program and Health Care Enhancement Act. Meanwhile, the Coronavirus Aid, Relief and Economy Security Act (“CARES Act”) cost up to USD 2.3 trillion (around 11% of GDP).
In addition, the Fed has also lowered its benchmark interest rate by 150 basis points in March to 0-0.25%. The reduction in interest rates accompanied the quantitative easing program, in which there was a jump from USD4.31 trillion on March 11, 2020, to USD7.17 trillion on June 3, 2020.
The stimulus package has saved the economy. The United States has seen its economic growth more than double what it was before the pandemic since the 2008-2009 financial crisis.