Unraveling Long and Variable Lags in the Stock Market

Long and Variable Lags': understanding the concept


Understanding ‘Long and Variable Lags’: An Introduction

July 29. 2023

Today, we delve into the intriguing concept of ‘long and variable lags,’ a term coined by the renowned economist Milton Friedman. This exploration is particularly pertinent given the Federal Reserve’s recent aggressive rate hikes, the most assertive since 2001. The current economic landscape is characterized by elevated debt levels and a populace that is financially worse off than it was in 2001. A significant proportion of Americans today lack even a thousand dollars in savings to cover an unforeseen expense.

The Concept of ‘Long and Variable Lags’

The concept of ‘long and variable lags’ was introduced by Friedman to elucidate the time it takes for economic policies to fully permeate and influence the economy. To simplify, ‘lags’ refer to the time delays between the implementation of an economic policy, such as changes in taxes, interest rates, or government spending, and the realization of the full effects of that policy on the economy.

Short Lags vs Long Lags

Some economic policies have short lags, meaning their impact on the economy is felt relatively quickly. For instance, if the government augments spending on infrastructure projects, the immediate beneficiaries, such as those in construction jobs, will start earning more and spending that money, thereby stimulating economic activity almost instantaneously.

Conversely, some policies have long lags, implying a considerable time lapse before their full effects are felt. For instance, if the government decides to invest more in education to enhance the skill level of the workforce, it may take years or even decades for the benefits of a more skilled workforce to manifest in the form of increased productivity and economic growth.

Variable Lags and Their Implications

The length of the lags can vary depending on the specific economic policy and the circumstances of the economy. Some policies might have longer lags in one situation but shorter lags in another. Understanding these long and variable lags is crucial for policymakers. If they fail to consider these lags, they might implement policies that have unintended consequences. For example, suppose they attempt to stimulate the economy during a downturn with a short-term policy. In that case, it might not have the desired effect until the economy has already recovered, leading to unnecessary inflation or other problems.

The Relevance of ‘Long and Variable Lags’ in the Current Economic Climate

The relevance of the concept of ‘long and variable lags’ becomes apparent when examining the current rate-hiking environment. It signifies that changes in interest rates may not immediately impact the macro economy, and the duration of this lag can vary, being unpredictable in nature.

It is reasonable to expect that the impact of the 11 rate hikes implemented by the Fed since March 2022 will eventually permeate the economy. The crucial question is when this impact will manifest. Typically, the effects of a rate-hiking cycle become evident within 6 to 24 months after the cycle concludes, drawing parallels to the situation in 2006.

Two years after the equity and debt markets hit long-term lows, the Fed started increasing the fed funds rate in the summer of 2004. They raised it 17 times over the next two years, each by 25 basis points, ultimately reaching a rate of 5.25%.

The subsequent bear market, which was part of the Global Financial Crisis, didn’t materialize immediately. Even one year after the final fed funds hike in June 2006, debt and equity market indices still surged. However, the first signs of trouble began to emerge in the latter half of 2007.

The Impending Economic Distress: A Perspective

Top economist David Rosenberg, in an exclusive interview with MarketWatch, argues that the US stock market has turned into a “get-rich-quick” scheme, concealing the forthcoming economic distress. He remains bearish on the economy, dismissing the possibility of a soft landing, and criticizes the Federal Reserve’s tightening policies.

Rosenberg points out that the Fed has raised interest rates by 500 basis points over the past five quarters to combat high inflation. While this has slowed down consumer-price increases, he believes there is still no chance of a smooth economic slowdown, given the aggressive tightening measures.

The Disconnect Between the Stock Market and the Economy

Despite the buoyancy of the equity market, with the S&P 500 rallying 19% in 2023, Rosenberg argues that this growth does not reflect the actual state of the economy. He sees the stock market’s surge as driven by speculative frenzy and “get-rich-quick” behaviour rather than an indication of economic strength.

For months, Rosenberg has warned about an impending US recession and raised concerns about a potential plunge in the S&P 500 and American consumers depleting their savings.

Conclusion: A Day of Reckoning May Be Closer Than We Think

In conclusion, the concept of ‘long and variable lags’ is a critical tool for understanding the dynamics of economic policy implementation and its subsequent effects. It underscores the importance of strategic timing and careful consideration of the broader economic context. As we navigate the current financial landscape, marked by aggressive rate hikes and high debt levels, it is crucial to remember the lessons of the past and heed the warnings of experts like Rosenberg. The stock market’s recent growth may be more of a speculative frenzy than a reflection of economic strength, and a day of reckoning may be closer than we think.

Articles That Cover a Spectrum of Timeless Topics

The Market Economy: Understanding Economic Systems

Economy: Exploring Different Economic Systems

What Is an Economy: An In-Depth Exploration Sept 20, 2023 An economy, in essence, serves as the intricate system through ...
"The Resurgence of House Poor: Balancing Homeownership Dreams with Financial Reality

House Poor: Navigating the Challenges of Rising Housing Cost

House Poor is it Back in Vogue? Surging Mortgage Rates Strain Budgets of New Homebuyers Sep 19, 2023 Over the ...
Huge Risk to US Economy; Reality or illusion

Huge Risk to US Economy: Fact or Fiction?

The Enigma of the Huge Risk to US Economy Sept 18, 2023 Uncertainty Surrounding Inflation Poses Downside Risk Over the ...
Inflation News: real inflation is coming

Inflation News: Real Inflation Set to Surge

Inflation News: Critical Resource Conflict Looms, Driving Real Inflation Sept 15, 2023 A resource conflict is looming, involving critical materials ...
Resource Wars Redefined: Beyond Traditional Conflicts

Resource Wars: Navigating a Shifting Global Landscape

Resource Wars Unveiled: The Global Transformation September 14, 2023 Introduction:  The "Resource Wars" concept has taken on a new and ...
Stock Market Sell-Off: Embracing Buying Opportunities

Stock Market Sell-Off: Embrace Fear & Seize Opportunities

Stock Market Sell-Off: Embracing Buying Opportunities Sept 12, 2023 Introduction: In the dynamic landscape of investment, the term "stock market ...
Stock Investing Mistakes: Fear Should Never Dominate

Stock Investing Mistakes: Fear Should Never Dominate

Stock Investing Mistakes 101: Never Panic Updated September 2023  Most investors lose money in the Stock Market, because they invest ...
Stock market crash today

Stock Market Crash Today: Should You Be Concerned?

Stock Market Crash Today: What Happens Tomorrow and Beyond? Updated Sept 2023 The most effective approach to financial markets involves ...
Pavlov Theory In Action With Trump Win

Defy Pavlov’s Theory: Buy When the Masses Sell

''Come to the edge,'' He said. They said, ''We are afraid. "Come to the edge,'' He said. They came. He ...
Copper ETF time to buy, markets & psychological warfare

Copper ETF: A Critical Decision – Buy or Beware?

Copper ETF: A Smart Play in the Bullish Copper Market Updated Aug 4  2023 In the good old days, before ...
manipulative behavior

Examples of Groupthink: Instances of Collective Decision-Making

Examples of Group Think: The Media Updated September 2023 It's essential to recognize that the same individuals who control the ...
precious metal stocks: ready to soar?

Unlocking the Benefits of Investing in Precious Metal Stocks

 The Advantages of Owning Precious Metal Stocks Updated Sept 2, 2023 Discussing such concepts within a historical context is optimal ...
Investing in a Bear Market: Are Bear Market Fears Overblown

Investing in a Bear Market: Ignore the Naysayers

Investing In A Bear Market: Strategies for Successful Investing Updated Sept 2, 2023 We will employ a historical backdrop to ...
China Great Long term opportunity

Yuan Vs Yen: Yuan On course to Challenge Yen

Currency Clash: Exploring the Yuan vs Yen Dilemma Updated Sept 2023 In recent years, the Yuan has made significant strides ...
ASAN Stock Price Trends

ASAN Stock Price Trends: Poised for Takeoff or Set to Decline

Analyzing ASAN Stock Price Trends: A Comprehensive Overview September 1, 2023 Before delving into the stock's performance and its potential ...