Chapter 16, Problem 1QQ

To determine

Identify the lag.

Answer to Problem 1QQ

Option ‘b’ is the correct answer.

Explanation of Solution

Option (b):

The lags are classified into two types, the inside lag and the outside lag, for a better implementation of the stabilization policy in an economy.  The inside lag represents the time between a shock to the economy and a policy action responding to that shock. In the case of economic stabilization, a long inside lag associated with the fiscal policy is the central problem of economic stabilization because it takes time for policymakers to recognize that a shock has occurred and to put appropriate policies into effect.

Hence, the inside lag is the time between when a shock hits the economy and when a policy responds to it. It is particularly long for fiscal policy.

Thus, option (b) is correct.

Option (a):

In the case of economic stabilization, the inside lag represents the time between a shock to the economy and a policy action responding to that shock.  A long inside lag associated with the fiscal policy is the central problem of economic stabilization because it takes time for policymakers to recognize that a shock has occurred and to put appropriate policies into effect. At the same time, monetary policy has a shorter inside lag than fiscal policy because a central bank can decide on and implement a policy change in less than a day.

Thus, option (a) is incorrect.

Option (c):

The lags are classified into two types, the inside lag and the outside lag, for a better implementation of the stabilization policy in an economy.  The inside lag represents the time between a shock to the economy and a policy action responding to that shock, and the outside lag represents the time between a policy action and its influence on the economy. This lag arises because policies do not immediately influence spending, income, and employment.

Thus, option (c) is incorrect.

Option (d):

The outside lag represents the time between a policy action and its influence on the economy. This lag arises because policies do not immediately influence spending, income, and employment.

Thus, option (d) is incorrect.

Economics Concept Introduction

Lags: The presence of lags is the one of the practical difficulties associated with economic stabilization that indicates the time to recognize and take actions to respond to shocks that hit the economy.