INFLATION RATE: The percentage change in the price level from one period to the next. The two most common price indices used to measure the inflation are the Consumer Price Index (CPI) and the GDP price deflator.
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The time lag that occurs between the implementation of a government policy designed to correct an economic problem and the complete impact of the policy. The impact lag is based on the multiplier process and can last up to a year or two or even longer. This "outside lag" is one of four policy lags associated with monetary and fiscal policy. The other three "inside lags" are recognition lag, decision lag, and implementation lag. All four policy lags can reduce the effectiveness of business-cycle stabilization policies and can even destabilize the economy. The impact policy lag occurs due to the time it takes for government policies, especially stabilization policies, to work their intended magic on the economy--once implemented. The impact lag is the last of the four policy lags. It arises only after a problem is documented (recognition lag), the corrective policy is identified (decision lag), and the policy is launched (implementation lag).
The key to the impact lag is the multiplier process, the cumulatively reinforcing change in production and expenditures caused by a shock to the economy. A change in production causes a change in expenditures, which then causes further changes in production and expenditures. The full impact of a government policy, as it works through this multiplier process, can take several years.
More on the MultiplierThe multiplier is the cumulatively reinforcing change in production, income, and consumption (and other expenditures) caused by a change in an autonomous expenditure. A change in an autonomous expenditure, especially investment and government purchases, causes a change in aggregate production. This change in production then causes a change a income, which subsequently induces a change in consumption and other aggregate expenditures. This change in expenditures then causes further changes in production, income, and expenditures.
Each "round" of this multiplier process involves a change in production, which triggers a change in income, which then induces and change in expenditures, which then comes full circle to another change in production. On average, a single multiplier round can take about two months. The multiplier process set in motion by a given autonomous shock to the economy typically involves a dozen or more rounds before reaching relative completion.
Government stabilization policies are designed to shock the economy and set the multiplier process in motion. Expansionary policies are enacted to stimulate the economy out of a business-cycle contraction. Contractionary policies are enacted to restrain the economy when inflationary pressures arise during an overheated business-cycle expansion.
The impact lag is the time it takes for policy shocks to work through this multiplier process; to stimulate the economy out of a contraction or restrain an overheated expansion; to cause a desired overall change in aggregate production and income. This intended impact, as it works through the multiplier, usually takes a couple of years.
Monetary versus FiscalThe impact lag is similar for both monetary policy and fiscal policy. Monetary policy shocks the economy through changes in the money supply and interests rates, which causes changes primarily in investment expenditures, but also consumption expenditures. Fiscal policy shocks the economy through changes in government spending and taxes, which causes changes primarily in government purchases, but also consumption expenditures.
The multiplier process is essentially same regardless of which autonomous aggregate expenditure changes. As such, the length of the impact lag is essentially the same for monetary policy changes in investment and consumption as it is for fiscal policy changes in government purchases and consumption.
Other LagsThe impact lag is one of four policy lags. The other three are recognition lag, decision lag, and implementation lag. These three lags are also termed inside lags.
- Recognition Lag: This is the time it takes to identify and document the existence of an economic problem that might require government action. The recognition lag arises because it takes time to collect and analyze economic data; to verify that an actual problem exists. This lag is seldom less than a month and typically lasts a couple of months.
- Decision Lag: This is the time it takes government policy makers (Congress, the President, the Federal Reserve System) to decide on a suitable course of action and to pass whatever legislation, laws, or administrative rules are necessary. This lag could be as short as a few days, but typically lasts weeks or months.
- Implementation Lag: This is the time it takes for the government sector to take the steps needed to activated or implement the chosen policy. This lag is also likely to take weeks if not months.
IMPACT LAG, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: February 25, 2024].
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