Policy lags - The delays created by lags can have one final...

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Policy lags Whichever method of policy is desired, a major problem exists. This problem is based on the fact that it takes time for economic problems to be noticed and dealt with. Detection lags refer to the amount of time between the onset of an economic problem and its detection. Policy lags, on the other hand, refer to the amount of time between the enactment of macroeconomic policy and the moment when that policy takes effect. For example, say that the economy is contracting. It must contract for a while before the policymakers recognize the contraction. When it is finally recognized, the policymakers must then decide which policy or policy rule to institute. Finally, once the policy or policy rule is instituted, it takes a fair amount of time for it to affect the economy. In the end, lags create significant delays in the progression from problem to solution in macroeconomic policy.
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Unformatted text preview: The delays created by lags can have one final and very important effect. If lags are so long that the economy corrects itself before the macroeconomic policies take effect, then the policies can actually worsen the situation. For instance, if the government uses fiscal policy to stimulate the economy, but the economy begins to correct itself before the policy takes effect, then the economy will be over-stimulated, resulting in possible inflation. There is little that can be done to correct lags. Because the macroeconomy is constantly fluctuating, it is impossible to simply begin policies when a change is detected. The presence of lags must be acknowledged and accounted for as a necessary evil implicit in macroeconomic policy. By using macroeconomic policy judiciously and in small increments, dangerous situations created by lags can be avoided....
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