State which limitation of monetary policy best describes the following circumstances. That is, does it cause...

State which limitation of monetary policy best describes the following circumstances. That is, does it cause a recognition lag, an implementation lag, or an impact lag.

A) A firm puts off purchasing a new building until it's sure long run interest rates will react to a cut in the Federal Funds rate.

B) A recession begins due to falling business optimism and falling planned investment but the Fed isn't monitoring investors sentiment very closely and doesn't know about the recession.

C) The FOMC meets but can't come to a conclusion as to what the proper course of action should be.

D) A bubble forms in the stock market setting up the stage for a crash but the Fed isn't able to tell the market is overvalued.

Solutions

Expert Solution

A) A firm puts off purchasing a new building until it's sure long run interest rates will react to a cut in the Federal Funds rate - Impact lag or response lag is the time it takes for corrective monetary policy to affect the economy once it has been implemented. Here, the time lag incurred till interest rates react to a cut in Fed Funds rate is an impact lag.

B) A recession begins due to falling business optimism and falling planned investment but the Fed isn't monitoring investors sentiment very closely and doesn't know about the recession. - Recognition lag is the amount of time it takes for monetary authorities to recognize a problem in the economy. This type of lag occurs primarily because it takes time for the economy to be tracked and for economic reports to be published, also because many economic indicators are backward looking and tell the story that has happened instead of what is happening now.

C) The FOMC meets but can't come to a conclusion as to what the proper course of action should be. - Once a problem has been identified, a course of action needs to be decided. A decision lag is the amount of time it takes for monetary authorities to make a decision regarding how best to handle an economic problem.

D) A bubble forms in the stock market setting up the stage for a crash but the Fed isn't able to tell the market is overvalued.- Recognition lag is the amount of time it takes for monetary authorities to recognize a problem in the economy.

Rahul Sunny answered 3 weeks ago

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