Have you ever wondered why the government is so terrible at fixing our economy? Well, its not all their fault. Today we’ll start a series about why they can’t quite make it work and the Lags associated with Fed Intervention.

Show me This Business Cycle thing

Below is what is known in MacroEconomics as “The Business Cycle”:
This is just a fancy way of saying “Showing that the economy goes up and down on a graph“.

The blue line is the business cycle as is, with its ups and downs- and the black dotted line is the long term trend of the business cycle.
As you will see, a free market economy (like the USA) always goes upward with time in the long term trend.

These ups and downs are awfully dramatic.

So what is the Gov’t Trying to Do?

The government’s goal is to achieve a line closer to the green one below, with less up and down swing. The less dramatic our economy as it continues its upward trend, the more content are the people. And as we all know- Government strives for the happiness of its people at all times….

Now – as the government tries to solves these issues with actions like tax increases and decreases, interest rate adjustments and spending, certain Time Lags come into play which disrupt their actions.

What do we mean by Time Lags?

If you’re a gamer, you’re familiar with the term Lag. There are three types of lag that affect the Fed’s response to economic woes or booms.

The Recognition Lag

The recognition lag takes place because when a Recession starts or ends, we simply can’t know it!
Huh?

It takes somwhere between 3 and 6 months for our Government Census bureaus to recognize that the economy has taken a turn for the better or worse.

So if the economy actually takes the turn downward at T1 (above), the government will continue high taxation, high interest rates and low spending as if the economy were in a boom until T2 months later.

This means that the government is actually fueling the recession for several months before it sees that it should be responding to a falling economy.

Well we Finally Realized it…

But notice… T2 is awfully close to the natural end of the recession.

Now that the Feds will start responding to a recession, it may well be nearing an end.
This means the Fed’s are unnaturally fueling a Boom now- which will have to come crashing back downward toward the trend, causing a more violent crash in the future.

But-
Even if we could somehow eliminate this Response Lag- the USA leaves us with two more.

So we’ve finally made it through the Response Lag.
The Feds have realized that we’re in a recession.

Putting a plan into action shouldn’t be hard! … Right?

Why Democracy Screws Up Economic Aid

As with everything else:
Our Government must argue over the means by which we come to an end.

The Bipartisanship of our government causes an Implementation Lag-
This is the time it takes for the government to draw up a plan and execute.

Let’s say that it now takes from T2 to T3 for the Government Officials to finally agree to a plan and implement it.

I’m being very generous illustrating it as less than the Response lag.
Implementation Lags are almost always MUCH longer than response lags.
Politicians don’t tend to get along well when it comes to money.

So as you can see- By the time that the government is responding to the crisis- we are naturally out of the Crisis and on our way up.

Atleast this must be where the lagging ends.

Wrong.

The government and our checkbooks have managed to make it through the Response Lag and Implementation Lags now.

The Recognition Lag is caused by the time it takes for Government’s actions to actually affect the economy.

Money takes time to Spread

As money is spent by the government and taxes are lowered- two things start to happen.

While highways are being built, schools are being built, people are being employed to perform meaningless tasks- money is being pulled out of the Government’s coffers (actually Lenders’, but that’s another post) and put in the peoples’.

Brokers in New York and across the country are also regaining their confidence in the economy.

These sort of events take time.

As you can see in the picture- By the time we reach T4, we have already come fully out of the dip- and the government stimulation has pushed us into an unnatural boom.

This boom MUST come back down to even out with the long term trend (because growth beyond the maximum can’t be sustained by the economy in the long run) causing an even worse recession.

This is Why the Government Can’t Help!

As the government tries to help, good intentioned they may be, they simply are unable to respond quickly enough and in the end do more damage than good.