Policy lags are commonly divided between inside lag and outside lag. Let's take a look at each.

Inside Lag

• Recognition Lag: Before any policy action can be pursued, the existence of the actual problem must be identified. It takes time to collect and analyze economic data. Unemployment and inflation data are usually available only a month or so after the fact. That is, the unemployment rate for January is usually available in February. Production and income data are reported quarterly and have an even longer lag. Gross production data for January, February, and March is seldom available until May. Once data are obtained, it must be analyzed and evaluated to ensure that it reflects the onset of an actual problem, such as a business-cycle contraction. This often requires several months of data to document an actual trend and determine that it is not just a temporary statistical aberration.


• Decision Lag: Once government policy makers have identified the problem, they need to decide on a suitable course of action, then pass whatever legislation, laws, or administrative rules are necessary. Often this requires an act of Congress, signed into law by the President. Congress is bound to debate the appropriate policy, make amendments, and promote particular political interests along the way. For example, if a business-cycle contraction is identified, Congress is likely to debate over an expansionary fiscal policy use of increased government spending or decreased taxes. But will the spending go for purchases or transfer payments? If it goes for purchases, then what types of goods or services are purchased? If taxes are decreased, which taxes are cut and who receives the extra income? These decisions could take days, weeks, or months.


• Implementation Lag: After a particular policy has been selected, steps then need to be taken to implement the policy. For any change in spending, the appropriate government agencies need to be contacted. More often than not, this involves a change in budget appropriations. The affected agencies then need to actually make changes in their spending. The act of spending is not instantaneous. Most agencies require competitive bids to identify product suppliers before they can make the expenditures. Even the employment, then subsequent payment, of additional workers takes time. The implementation of fiscal and monetary policy is also likely to take weeks if not months.

Outside

• Impact Lag: This lag is the time it takes any change initiated by a government policy to impact the producers and consumers in the economy. A key part of the impact lag is the multiplier. An initial change in government spending, taxes, the money supply, interest rates must work through the economy, triggering changes in production and income, which induces changes in consumption, which causes more changes in production and income, which induces further changes in consumption. Each "round" of changes (consumption expenditures on production that are induced income) is likely to take a month or two. Several rounds are needed (six to ten or more) before the bulk of this impact is realized. An impact lag of one to two years is not uncommon.

Monetary versus Fiscal

However, the story is a little different for inside lags. While the recognition lag is much the same regardless of the policy used, the decision and implementation lags tend to be different for monetary versus fiscal policy.

• Monetary Policy: The decision lag for monetary policy tends to be relatively short. Monetary policy decisions are made by the Federal Open Market Committee of the Federal Reserve System, a small group consisting of 12 members and an relatively powerful chairman. Monetary policy is their primary task. This committee meets every six weeks or sooner if needed usually comes to a policy decision when faced with a business-cycle problem with very little delay.

  The implementation lag is also relatively short. Policy decisions are implemented by a special branch of the Federal Reserve System devoted to this task. Once a policy action is identified, then the implementation steps are begun almost immediately (often by the end of the day). And because monetary policy works through financial markets (which tend to operate quickly), implementation is completed in short order.



• Fiscal Policy: The decision lag for fiscal policy tends to be relatively long. Fiscal policy decisions are made by Congress and the President, more often than not, literally involving and act of Congress signed into law byÊthe President. Because Congress represents diverse interests, finding a fiscal policy that is acceptable to a majority can take time. And hopefully this decision is acceptable to the President, as well. If not, then the decision making process continues, and the decision lag continues.

  The implementation lag also tends to be relatively log. Any changes in government spending or taxes need to work through the government agencies and bureaucracies before than are implemented. Bureaucracies, by their very nature, are slow to act as they make sure that necessary rules and procedures are followed. But this tends to lengthen the time needed to implement fiscal policy.

Destabilizing Policies

For example, if the impact of expansionary fiscal policy is not seen for a year or more after the onset of a business-cycle contraction, then the stimulation might occur during the ensuing expansion, which can then overstimulate the economy and cause inflation.