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What Causes Lags in Monetary Policy?

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  • Written By: Esther Ejim
  • Edited By: Kaci Lane Hindman
  • Last Modified Date: 11 April 2014
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Just like the name suggests, monetary policy lags are the time lapses that may occur in between the onset of an undesirable economic condition and the actual action by government to address it as well as the time it takes for the actions taken by either the government or the central bank to take hold. In this sense, the lags in monetary policy refer to the time that may have elapsed in between the time the monetary policy was introduced and the actual time it takes for such a policy to begin to take effect in the economy. Monetary policies refer to the policies that are used by the central bank to control undesirable economic conditions in the economy, including slow growth and inflation. When monetary policies, like increased interest rates, have been introduced, certain factors like the means of transmission may contribute to causing a delay in its implementation.

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One of the factors that contribute to lags in monetary policy is the means of transmission of the monetary policy to the economy. Assuming the aim of the monetary policy is to curb rising inflation, the central bank might decide to increase the interest rates, in which case the other banks in the economy will be the main vehicles for the transmission of the monetary policy. If the central bank increases interest rates, the other banks will reciprocate by also increasing their own interest rates and other charges on financial transactions. It will also be manifested in the manner in which greater restrictions will be attached by such banks to the issuance of loans to consumers.

Since the aim of the central bank is to curtail the consumption that is the cause of the inflation, the sign of lags in monetary policy here is the time between when the central bank first implemented the policy and the time it actually started to take effect. The desired effect in this case is to slow down consumption. As such, the lags in monetary policy last until consumers really start to slow down the pace of their consumption of goods and services. Another source of lag in monetary policy is a consequence of the length of time it takes for investments by consumers and businesses to show any type of appreciable response to the monetary policy that is in place. Basically, the lag in monetary policy is usually the result of various adjustments by different sectors of the economy to the new monetary policy.

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bear78
Post 3

@fify-- My instructor said that lags in monetary policy are five or six quarters on average. A quarter is four months, so it can take sixteen months to start seeing the full effects of a new monetary policy.

literally45
Post 2

@fify-- It's difficult to say. There are many factors involved and sometimes these lags can be unpredictable. One may start seeing the effects of a monetary policy within days and weeks, but it may take months to get the economy where it should be. So it's not possible to give an exact time frame.

The Central Bank is actually always keeping track of the economy. Ideally, if interest rates, money supply, inflation, employment, etc. are going in an undesirable direction, the Bank should do something to prevent it. Interest rates should be adjusted before inflation becomes too high or too low.

In a well managed economy, if there are no surprises, things should be stabilized and sustained. Lags in monetary policy usually occur as a result of a surprise event or factor that upsets the economic balance. The Central Bank may be unprepared and even if a new policy is put in place, it can take time to see results.

fify
Post 1

Is it possible to put a time frame for these lags? Let's say the Central Bank increased interest rates today. When will we see a decrease in inflation? Will it take days, weeks or months?

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