CHAPTER 26 Money and Inflation 685 The data lag is the time it takes for policymakers to obtain the data that tell them what is happening in the economy Accurate data on GDP, for example, are not available until several months after a given quarter is over The recognition lag is the time it takes for policymakers to be sure of what the data are signalling about the future course of the economy For example, to minimize errors, the government will not declare the economy to be in recession until at least six months after it has determined that one has begun The legislative lag represents the time it takes to pass legislation to implement a particular policy The legislative lag does not exist for most monetary policy actions such as open market operations It is, however, important for the implementation of fiscal policy, when it can sometimes take six months to a year to get legislation passed to change taxes or government spending The implementation lag is the time it takes for policymakers to change policy instruments once they have decided on the new policy Again, this lag is unimportant for the conduct of open market operations because the Bank of Canada s trading desk can purchase or sell bonds almost immediately upon being told to so Actually implementing fiscal policy may take time, however; for example, getting government agencies to change their spending habits takes time, as does changing tax tables The effectiveness lag is the time it takes for the policy actually to have an impact on the economy An important argument against discretionary policy is that the effectiveness lag is long (often a year or longer) and variable (i.e., there is substantial uncertainty about how long this lag is) Discretionary and Nondiscretionary Positions Now that we understand the considerations that affect decisions by policymakers on whether to pursue discretionary versus nondiscretionary policy, we can examine when each of these policies would be preferable Advocates of discretionary policies view the wage and price adjustment process as extremely slow They believe that nondiscretionary policy is costly because the slow movement of the economy back to full employment results in a large loss of output However, even though the five lags described above result in a delay of a year or two before the aggregate demand curve shifts to AD2, the short-run aggregate supply curve moves very little during this time The appropriate path for policymakers to pursue is thus a discretionary policy of moving the economy to point in Figure 26-11 CASE FOR A DISCRETIONARY POLICY Opponents of discretionary policy view the wage and price adjustment process as more rapid than advocates of discretionary policy and consider nondiscretionary policy less costly because output is soon back at the natural rate level They suggest that a discretionary policy of shifting the aggregate demand curve to AD2 is costly because it produces more volatility in both the price level and output The reason for this volatility is that the time it takes to shift the aggregate demand curve to AD2 is substantial, whereas the wage and price adjustment process is more rapid Hence before the aggregate demand curve shifts to the right, the short-run aggregate supply curve will have shifted rightward to AS2, and the economy will have moved from point 1* to point 1, where it has returned to the natural rate level of output Yn After adjustment to the AS2 curve is complete, the shift of the aggregate demand curve to AD2 finally takes effect, leading the economy to point 2* at the intersection of AD2 and AS2 CASE FOR A NONDISCRETIONARY POLICY