Question

“Lags” in monetary policy ( I want the answer computer typing NOT handwriting)

Answer 1

Before going to time lags, we must first understand the meaning of related topics.

Monetary policy : It is a credit control measure used by central bank of a country.

Time Lag : Timing relation between the adoption of monetary policy measures and the resulting effect.

Now, in monetary policy the main limitation is it takes some time to central bank of a country to recognize if there is a boom or depression. Due to which there is a delay in taking decisions and thus sometimes our monetary policy fail due to this sole reason.

Friedman have divided time lag in 3 parts :

1. Recognition lag
2. Administrative lag
3. Operation lag

Recognition lag : Time between development of need of action and recognition of the need of monetary policy. Suppose there is a boom in the economy but central bank realizes this after 3 months, then the action against it can be taken only after 3 months. So this time of 3 months is recognition lag.

Administrative lag : It relates to the period of time between need of action and actual data on which action is taken. By continuing the previous example, now central bank knows there is a boom in economy but it will take some time for central bank to decide which policy should be introduced to reduce the boom. This time lag is called administrative lag.

Operation lag : Time of period between adoption of monetary policy and final effect of monetary policy on economy. Suppose, to control boom Central Bank increases the rate of interest at which commercial banks can borrow from central bank. This will reduce the money supply of the economy. Due to which interest rate for borrowings will rise for firms. Thus they will invest less and this will lead to control in boom. But this will not happen overnight. It will take some time for each and every individual of the economy to react on the situation they are faced.