Learn about the different types of lags in fiscal policy and how they can impact the effectiveness of economic interventions.
Types of Lags in Fiscal Policy
There are delays or lags involved in the steps required before a policy action can be taken after a disturbance has occurred and the process by which the policy action affects the economy. The lags are of two types inside or internal lags, and outside or external lags.
Internal or Inside Lags:
Internal lags in the time period that elapses between the occurrence of a disturbance to the economy and the time a policy action is undertaken such as a tax cut or an increase in the money supply. The internal or inside log consists of three lags i.e. recognition lag, decision lag, and action lag.
Recognition Lag:
The recognition lag is the time period that elapses between the time a disturbance occurs and the time the policy makers recognize that a policy action is required. Recognition ‘ag has normally been positive The length of the recognition ‘ag is the same for both the monetary and fiscal policies.
Decision Lag:
Once the problem has been recognized the need occurs for the decision to be taken regarding the policy action. The time period that elapses between the time a problenT is recognized and the time when the policy decision is made, is known as decision lag. The decision lag for monetary policy is shorter in length than that of the fiscal policy.
Action Lag:
The action lag is the period that elapsas between the policy decision and its implementation. The action lag is very short for monetary policy.
However, the decision lag for fiscal policy is longer because the decision is to be made between reducing tax collections or increasing government expenditures, if an expansionary fiscal policy is to be initiated. Similarly, action lag for fiscal policy are also longer.
External or Outside Lags:
The external lag is the period that elapses between the time a policy action is taken and the time this action affects the economy. The outside lag is relatively short for fiscal policy and longer for monetary policy. Fiscal policy directly influences the aggregate demand through its influence on the interest rate. The influence of fiscal actions on the economy is more certain than of monetary policy.