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Stabilization Policy Lags

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PPGPortal > Home > Concept Dictionary > S > Stabilization Policy Lags
 
Stabilization Policy Lags

Delays in the impact of fiscal and monetary policy on aggregate demand.

(Peter Dungan, PPG1002H)

------------------------

Lags are important because they can cause stabilizing actions to be mistimed, which can actually be de-stabilizing. There are two major types of lags, “inside” lags and “outside” lags. Inside lags are caused by the time that is required to initiate the policy response. It takes time to recognize that there is a problem, make a decision about how to address it and to then translate that decision into action. These are all “inside lags” that often make it difficult to effectively use stabilization policy.
Outside lags are caused by the time that is required for the policy, once enacted, to impact the economy. For example, when interest rates are cut, it may take some time for businesses and consumers to react to the change. Many firms and households plan their finances in advance and cannot rapidly change their decisions in response to short term interest rate cuts. Most firms and consumers will eventually react to a stabilization policy, but some will do so quickly and some will do so slowly. For this reason, outside lags are generally “distributed lags” which means that the effect of policy changes on the economy build up to their full potential over the course of several quarters. 

References


Dungan, Peter. Class Lecture. PPG1002H Microeconomics for Policy Analysis. University of Toronto School of Public Policy and Governance.

Mankiw, N.G., Kneebone, R.D., McKenzie, K.J., Rowe, N. Principles of Macroeconomics: Third Canadian Edition. Harcourt Brace Canada: Toronto, 2004.
     
Stabilization Policy Lags

Delays in the impact of fiscal and monetary policy on aggregate demand.

(Peter Dungan, PPG1002H)

------------------------

Lags are important because they can cause stabilizing actions to be mistimed, which can actually be de-stabilizing. There are two major types of lags, “inside” lags and “outside” lags. Inside lags are caused by the time that is required to initiate the policy response. It takes time to recognize that there is a problem, make a decision about how to address it and to then translate that decision into action. These are all “inside lags” that often make it difficult to effectively use stabilization policy.
Outside lags are caused by the time that is required for the policy, once enacted, to impact the economy. For example, when interest rates are cut, it may take some time for businesses and consumers to react to the change. Many firms and households plan their finances in advance and cannot rapidly change their decisions in response to short term interest rate cuts. Most firms and consumers will eventually react to a stabilization policy, but some will do so quickly and some will do so slowly. For this reason, outside lags are generally “distributed lags” which means that the effect of policy changes on the economy build up to their full potential over the course of several quarters. 

References


Dungan, Peter. Class Lecture. PPG1002H Microeconomics for Policy Analysis. University of Toronto School of Public Policy and Governance.

Mankiw, N.G., Kneebone, R.D., McKenzie, K.J., Rowe, N. Principles of Macroeconomics: Third Canadian Edition. Harcourt Brace Canada: Toronto, 2004.

Approved for glossaryposting by Ben Eisen on January 8, 2011


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