How do lags affect stabilization policy? Your answer should include three specific types of lags.

Question

What will be an ideal response?

Answer 1

Lags make stabilization policy difficult, if not counterproductive. The first type of lag may be called a recognition lag or an information lag. This refers to the length of time it takes for policymakers to recognize that an economic problem has occurred. This lag is unavoidable in that data are almost always collected after conditions change. The second type of lag may be called the policy lag. This is the length of time it takes for policymakers to take appropriate action. With respect to this lag, monetary policy is much superior in that the FOMC has only 12 members and meets at least eight times per year. Congress, on the other hand, may take years to actually pass a tax law or a spending change. The third lag may be called the expenditure lag and refers to the length of time it takes for a particular policy to affect aggregate demand and the macroeconomy. In this case, fiscal policy has the advantage because changes in government spending directly affect the expenditure schedule and the level of income and employment. Monetary policy works more indirectly. It first affects interest rates and then investment spending and then aggregate demand. Because both fiscal and monetary policies have advantages and disadvantages, the problems of lags does not point to a clear superiority for either fiscal or monetary policy.