Question

Suppose that in January 2026 the government successfully carries out the type of policy necessary to restore the natural level of output described in the previous question. In March 2026, consumer confidence increases, leading to an increase in consumer spending. Due to the??? associated with implementing monetary and fiscal policy, the impact of the government's new policy will likely ??? once the effects of the policy are fully realized.

Answer 1

The impact of government policy on restoring natural output levels may be delayed due to the long time lags associated with implementing fiscal policy, whereas monetary policy usually has shorter time lags and can respond more swiftly to changes in consumer confidence and spending.

Step-by-step explanation:

The question deals with the concept of time lags associated with the implementation of monetary and fiscal policy. Specifically, it refers to the time it takes for a policy's effects to be fully realized in the economy. When consumer confidence increases and consumer spending rises, the impact of government policies aimed at restoring natural output levels will likely be influenced by time lags. Discretionary fiscal policy often has longer time lags due to the recognition lag (time to realize an economic downturn), legislative lag (time for bills to be debated and passed), and implementation lag (time for the funds to be disbursed and programs to start).

For instance, fiscal policy takes effect through government spending and taxation, which often involve complex negotiations and legal procedures, leading to a delay in their influence on the economy. Conversely, monetary policy, guided by the central bank, usually has shorter time lags. This includes open market operations that the Federal Reserve can quickly initiate, as well as changes in interest rates which can take effect relatively quickly.