Question

Identify and explain the five lags associated with fiscal policy.

Short answer

The five lags associated with fiscal policy are recognition lag, legislative lag, implementation lag, effectiveness lag, and impact lag. The recognition lag involves recognising the need for intervention, legislative lag refers to the time needed for legislative approval, the implementation lag is the time required to execute the policy, effectiveness lag represents the time for the policy to significantly show effects on the economy, and finally, impact lag is the time for the effects to spread across the economy.

Step-by-step solution

Define Recognition Lag

Recognition lag is the first lag in fiscal policy. It refers to the time it takes for policymakers to realize that a policy intervention in the economy is necessary. It's often caused by the time it takes to gather adequate data and recognize that the economy is in a recession or overheating.

Explain Legislative Lag

The legislative lag refers to the time taken to get a policy change through the government's legislative body. For instance, in most countries, budget proposals, tax changes, new spending measures, and other fiscal policies require parliamentary or congressional approval before they can be enforced.

Detail Implementation Lag

Implementation lag refers to the time taken to put the approved policy into effect. After the legislative body has approved a change, the relevant government agencies must administer it. This procedures can be time-consuming and often involve additional delays.

Discuss Effectiveness Lag

The effectiveness lag is the time it takes for the complete implementation of the policy to have a noticeable effect on the economy. The time taken for new government spending or taxation policies to significantly affect employment, inflation, and other economic indicators is known as effectiveness lag.

Explore Impact Lag

The final lag, known as impact lag, refers to the time it takes for the changes the policy brought about in the economy to spread and be felt throughout the entire economic system. This lag can be quite considerable because changes in the economy often start in one sector or region before slowly spreading to the rest.