Katelyn Peters has a writer and editor for more than five years who focuses on both investing and personal finance content. In addition to her experience in finance, she is also a volunteer editorial contributor for Litmus Press, O Books, and The Post-Apollo Press.
Updated February 24, 2024 Reviewed by Reviewed by Robert C. KellyRobert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital.
Fact checked by Fact checked by Yarilet PerezYarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more. Her expertise is in personal finance and investing, and real estate.
Response lag, also known as impact lag, is the time it takes for monetary and fiscal policies, designed to smooth out the economic cycle or respond to an adverse economic event, to affect the economy once they have been implemented.
Learn more about response lag and the timeframe before policy changes are noticed or measurable within an economy.
Response lag is one of four policy lags that can make it hard for policymakers to improve the performance of the economy; policy lags can even destabilize the economy. Because of recognition lag, it may take months or even years before politicians acknowledge that there has been an economic shock or a structural change in the economy. Then there is decision lag, with policymakers debating the appropriate policy response, followed by implementation lag before any fiscal or monetary policy action is taken.
Response lag comes last. After officials have recognized a macroeconomics issue they want to address, decided on the desired policy, and actually implemented the policy, it then takes time for the policy measures themselves, such as an injection of credit into the financial system or the issuance of stimulus payments, to work their way through the economy and ultimately have an effect on the economic variables of interest.
Response lag occurs because any monetary fiscal policy, once implemented, must then work through a series of transactions that occur between market participants. Each of these transactions takes time, and businesses, consumers, and investors along the chain of transactions may wait for some time before completing the next transaction. Eventually, once all the necessary transactions take place, the outcome of the policy may be observed.
To circumvent response lag, central banks use a technique called forward guidance, in which they communicate the direction they want to take to influence an economy. Businesses and individuals then use this information to make financial decisions instead of waiting for the effects of a policy change to be felt.
For example, during periods of economic distress, the direct issuance of stimulus checks to taxpayers has become a popular tool of fiscal policy. However, once the policy has been implemented and the checks are in taxpayers' hands, several more steps need to occur before the policy can have its desired stimulatory effect. Taxpayers need to cash or deposit the checks with a financial service provider, then they need to spend the money they get on goods and services.
Therefore, stimulus policies depend heavily on the multiplier effect: the businesses where taxpayers have spent their stimulus money need to in turn deposit the money in their banks and then spend it on wages, raw materials, or other goods purchased from other businesses.
Because all economic action necessarily takes place over time, this chain of transactions may take a while. The process may be delayed if, at any step along this chain of transactions, the holders of the stimulus money hang on to it for a while as savings rather than spending it. Only once the new stimulus money has circulated throughout the economy can the full effect of the policy be felt and observed by policymakers. The time interval between this point and the point of implementation (the mailing of the checks) is the response lag of the stimulus policy.
In the popular imagination, central banks can control the economy at will by manipulating the money supply and interest rates. In reality, it is difficult to determine how effective monetary policy has been, never mind knowing how tight monetary policy should be.
Central banks also wait to implement monetary policy until they are sure a change is warranted. Quick policy changes and adjustments can shock the market and economy into undesirable conditions—but so can waiting too long.
When the Federal Reserve cuts the federal funds rate, it can take 18 months before there is any evidence of that changes’ impact, and central banks can find themselves pushing on a string. This inability to fine-tune the economy, with the aim of evening out business cycles, is perhaps why many tightening cycles in the Fed's history have been followed by a recession or depression.
There are many reasons for the response lag on interest rate cuts. Homeowners with fixed-rate mortgages may find a processing delay in getting mortgage companies to process their refinancing applications, and banks often delay passing on bank rate cuts to consumers. Businesses and consumers may also wait to see if a rate change is temporary or permanent before making new investments. And if lower interest rates weaken the currency, it can take months before new export orders are placed.
The impact of tax cuts or changes in government spending is more immediate—although they also affect the long-run trend rate of economic growth. But fiscal policies still take months to have any effect on the economy.
For example, President Biden's American Rescue Plan Act (ARPA) was announced Jan. 20, 2021, providing billions in Covid relief, community investments, and economic stimulus. The plan's $1,400 stimulus checks didn't go out until March 2021, and the full effects of the plan were still being realized two years later.
Other policies encourage saving more to improve productivity. A higher savings rate hits current consumption but leads to more investment and higher living standards in the long run. Quantitative easing has been criticized because it does little to encourage real capital investment, which would improve the productive capacity of the economy, and can encourage risk-taking among investors.
Response lag is the timeframe where the effect of a change in or implementation of policy is noticeable in an economy.
Recognition lag is the timeframe between a commodity's price change and the time the change is passed on to consumers and businesses in an economy.
Transmission lag is the time between a policy decision and the time the change is implemented.
Economic policies aren't immediately effective. Response lag measures the time it takes for economic policy changes or stimulus to be felt and observed. It's one of four types of lag in an economy, the other three being recognition lag, decision lag, and implementation lag.
Response lag can be "long and variable," with changes taking months or even years to work their way through the economy. Therefore understanding response lag is important for policy advisers, analysts, politicians, and workers to more fully grasp the results and effectiveness of economic decision-making.