Kinds of Lags

Any kind of aggregate demand policy would face the problem of lags. Some economists have listed the different lags both monetary and fiscal policy would face:

Recognition lags

A recognition lag is a lag between the time a boom or a slump occurs and the time when the authorities know that it has occurred. It can take this information several months to become available. For example, I am writing in late August, but the latest figures for real GDP I can get on-line are for the second quarter -- April-June. If the economy has gone into recession since June, the statistics won't show it for several more months. (Check the data on the FRED data base and see how old they are when you read this).

Implementation lags

This is the time required to put a new policy into action. This can be quite short for monetary policy -- since the Fed meets monthly and can decide to buy or sell bonds on the open market with little delay. Implementation lags can be quite long for fiscal policy, if (as has usually been the case) federal legislation is required. This will depend a bit on the approach to fiscal policy. The Kingdom of Sweden has had a law that allows corporations to put some of their profits into an investment fund, and postpone the tax on the funds until they are taken out and used for investment. In a period of recession, the taxes might be avoided completely. At the government's discretion, a period of open re-investment could be declared, and funds invested during that period would be excused from taxes completely. In effect, the companies would get a tax cut, on the condition that they time their investment to come during a recession. This sort of policy can be put into practice about as fast as monetary policy. In the American tax and government spending system in the period of the 1950's through the 1990's, there are a number of provisions that are "built-in stabilizers," in that they come into effect automatically in a recession, without legislation.

Response lags

This is the time required for the policy to have an effect on people's spending decisions, after the policy has gone into force. If people get a tax cut, for example, they don't increase their spending immediately. But because monetary policy works indirectly, through the interest rate, it seems likely that the response lags for monetary policy are even longer, and they could be quite unpredictable.

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