Raphael Bostic, Essay: On Long and Variable Lags in Monetary Policy

Monetary Policy Lag

“That happens gradually. A large body of research tells us it can take 18 months to two years or more for tighter monetary policy to materially affect inflation. You may be wondering: Why does it take so long?”

“The US economy is a vast, complex ecosystem of interrelated forces. So, it takes businesses and consumers time to recognize, feel, and act on changes in financial conditions. For instance, firms are continually making capital investments that require financing. If a company has already started to build a factory or introduce a new product line, it will often continue to move forward rather than halt the project in midstream, even though financing costs have changed since it launched the venture. The bite comes for planned projects or expansions down the road; companies may be less likely to start these.”

“To be sure, there is considerable uncertainty about how these policy lags will play out … In fact, one school of thought suggests that the lags may be shorter in part because of policy guidance that, in effect, allows financial markets to react to policy before we implement it.”

Inflation, Policy and Recession

“Right now, job number one for the FOMC is to tame inflation that is unacceptably high. If high inflation persists for too long and becomes entrenched in the economy, we know that more prolonged and deeper economic pain will ensue. So, while there are risks that our policy actions to tame inflation could induce a recession, that would be preferred to the alternative.”

“But, as I noted in recent remarks, a recession is not a foregone conclusion, and we will try to avoid one if at all possible. And there are many scenarios in which a recession, if it does occur, could turn out to be mild by historical standards.”