Fiscal policy lags occur due to delays in recognizing and implementing solutions to economic problems. Internal and external delays are the main categories, with recognition, decision, and implementation being subcategories of internal delay. Impact lags occur due to the time it takes for the full impact of fiscal policy to be felt.
Lags in fiscal policy result from delays in recognizing problems with the economy and implementing solutions. Governments employ fiscal policies to reduce unemployment, limit inflation, reduce the impact of business cycles and facilitate economic growth. Such objectives are achieved through government spending, grants or commercial loans, and collecting revenue through taxation. Expansive fiscal policy stimulates the economy by lowering taxes, increasing government spending, and providing more transfer payments to businesses in order to fight unemployment and increase aggregate demand. Contractionary fiscal policy involves a government that cuts its spending and raises taxes to prevent inflation, slowing down economic growth.
There is a delay between the development of an economic issue that requires expansionary or contractionary fiscal policy and the government’s recognition and institution of a solution to the problem. These delays are known as fiscal policy delays. Internal and external delay are the main categories of lags in fiscal policy. Recognition, decision, and implementation are three subcategories of internal delay. Impact is a term used to describe external policy lags. Time lags are an issue for government officials and policymakers because they inhibit the effectiveness of economic action plans and can do more harm than good if implemented too late in the business cycle.
The amount of time that elapses between the development of economic problems and the reaction of government officials is known as an internal delay. Lags in recognition fiscal policy represent the time required for an economic issue to be delineated. Macroeconomic policy advisers must obtain and evaluate economic data before highlighting the cause of economic distress. Unfortunately, numbers related to inflation and unemployment are not usually available instantly. Consultants also need to evaluate several months of data to ensure an accurate prognosis.
Decision lags reflect the delay that occurs from the moment the problem is identified until the moment the government mobilizes. Centrally planned economies have relatively short lags. In democracies, decision lags are longer because legislatures need to debate, amend, and vote on an appropriate course of action. If the legislator or head of state cannot reach consensus, fiscal policy lags could be even longer.
Once a decision is made regarding fiscal policy, there is a delay in its execution. These implementation lags are long and tedious due to the bureaucratic nature of most government agencies. For example, changes in government spending require affected departments to change their budgets and adjust their spending habits. Providing grants or transfer payments often involves solicitations and interviews and requires agencies to ensure they comply with various laws. Revenue from the new tax is typically not generated until the following year.
Lags in foreign fiscal policy represent the period between implementation and the reaping of economic benefits. These impact lags are due to the fact that government changes must cut across all aspects of the economy. For example, a government subsidy can induce a company to hire more workers and increase production. Consequently, consumer demand brought on by newly hired workers leads to further increases in production and hiring. Such cycles must run through all sectors and industries of an economy before the full impact of fiscal policy is felt.
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