Economics and politics affect each other in many ways. By pursuing a political agenda, a government usually affects the economy. A government often tries to stabilize or grow the nation's economy. Economic policy is much more difficult to implement than other government policies. One important problem is the occurrence of time lags. In economics, a time lag refers to the time that it takes an economic policy to be created and implemented. It also refers to the time it takes for the policy to affect the economy. Often an economic policy is used to solve a problem within the economy. As the government works on policies, the economy continues to evolve. By the time the policies are created and implemented, different economic problems have formed. These economic policy time lags fall into three categories:

• recognition lag
• decision lag
• effect lag

CS Question #1: What is a time lag?

A recognition lag is the time it takes a government to realize the need for a new economic policy. There are many economic indicators used by policy makers. The indicators help them to review the current state of the economy. Policy makers watch unemployment rates and inflation rates. They also review stock prices, the sales of new homes, and many other statistical indicators. Often, however, this information is available only after the fact. These statistics can also be misleading. A policy maker must be careful to determine the difference between normal fluctuations and real problems. A government must often wait until there is absolute certainty before creating new policy. It can take months, sometimes years, for the unemployment rate or inflation to rise to a level where the government recognizes a problem.

After policy makers recognize a problem, they must decide what action to take. Because economics and politics affect each other so closely, solutions to economic problems are more complex. Different political parties want to solve economic problems in different ways. A liberal government, like the Democratic Party, is more likely to practice stabilization policies. A conservative government, like the Republican Party, is more likely to rely upon the market to correct itself. Political debate often slows the decision process. The decision lag is usually shorter in matters of monetary policy than in those of fiscal policy. The central bank, known as the Federal Reserve, often sets monetary policy overnight. The Federal Reserve is not a political organization. Therefore, it does not have to consider political agendas when applying solutions. On the other hand, fiscal policy takes more time and effort. Setting fiscal policy, like increasing or decreasing taxes, usually requires approval from Congress. Since Congress consists of members of two political parties, there is a great deal of time spent debating the policies.

CS Question #3: What is the decision lag?

The third time lag is the most complex. The effect lag refers to the time it takes for an economic policy to affect the economy. Once a problem is realized and a solution is created, the effect can take months or years to be felt. Some policies may be felt relatively quickly, but others may take many years. Often, a president's term in office has ended before economic policies affect the economy . This makes establishing economic policy difficult. It is hard to judge whether the policy is correct without seeing the results in the economy. Some economists argue that new economic problems develop before the policy can take effect. These new problems void the original problem and can create more problems. Other economists argue that automatic stabilization policies should be created. These could be implemented with a shortened effect lag. Some nations allow certain authorities the power to create economic policy without the consent of the legislature. Other nations have laws that define what actions will be taken under certain economic conditions.

CS Question #4: What is the effect lag?

Further Thought:

1. How can the problems of lags be solved?
2. Why is monetary policy quicker to implement than fiscal policy?
3. How do the solutions to time lags reflect the competing political ideas about big government vs. small government?