Wednesday, May 14, 2008

pro-cyclical fiscal policy....

(it's not just for Latin America anymore people)

In discussions of fiscal policy, a number of lags are important. The recognition lag is the time between when a problem starts and when we know it has started. The implementation lag is the time between when we realize there is problem and when we get an action through the political system. The impact lag is the time between when the action is taken and when the effect of the action is felt.

If these lags are too long, then the policy action risks being pro-cyclical rather than counter cyclical, which is to say it will hit the economy after the downswing is over.

That certainly seems to be the case for the US now, at least based on the following:

1. recession probabilities have faded:

According to Intrade, the probability peaked at 75% in mid April and had declined to below 30% in early May....

2. just when the stimulus checks are arriving:

For Social Security numbers ending in 00 through 09, the paper checks will be mailed starting May 9 and will continue through May 16. A similar process will be repeated in the following weeks.

Even in this super-fast, super-charged, election year political atmosphere(which produced a negative recognition lag???), the policy will probably be procyclical and thus put more upward pressure on prices.


kebko said...

Couldn't the prediction market be reacting to the stimulus checks? Maybe the checks are being sent at just the right time, and the prediction markets are acknowledging that.

Anonymous said...

seems extremely unlikely. The prediction markets sharply in March, just after the President signed the Economic Stimulus Act into law.