Question

Critics of Keynesian fiscal policy point out that the “lag problem” presents a quite serious     challenge to both the theory and the execution of the policy itself. What is this problem, what kinds of lags are there and why is it a weakness?

Answer 1

Lags reduces or delays the the impact of fiscal policy. The four lags that can reduce the effectiveness of fiscal policy are as follows:

a. Data Lag : A policymaker is generally unable to notice the fluctuations in the economic activity unless data on real GDP and unemployment are collected.

b. Recognition Lag: It takes times for the problem to be realized or recognised in the economy. If the problem is permanent, then there is a need to worry.

c. Decision Lag: It takes a while before the legislature can decide what policy measures needs to be taken and there are disagreements also which further delay the policy decision. Thus, decision lag exists in the fiscal policy.

d. Implementation lag: When a bill is passed after taking into consideration all these factes, there is implementation lag in the economy and the bill finally takes time to be implemented in the economy.

These lags reduce the speed of correction mechanism in the economy and economt takes time to reach its initial equilibrium point.