What Is Recognition Lag?
Recognition lag is the time delay between when an economic shock, such as a sudden boom or bust, occurs and when economists, central bankers, and the government realized that it has occurred. The recognition lag is studied in conjunction with implementation lag and response lag, two other measures of time lags within an economy.
- Recognition lag is the delay between when an economic shock occurs and when it is recognized to have occurred by economists, central bankers, and the government.
- Delays occur because economic processes always take place over time and data documenting the state of the economy is not immediately available and then takes time to accurately analyze.
- On average, a recognition lag takes between three and six months.
- Meanwhile, the entire process of identifying and remedying an economic problem can take anywhere between six months to three years, meaning issues are often addressed late.
Understanding Recognition Lag
Followers of the market will have noticed that economists often signal a recession a while after it actually begins. Recognition lags may be days, weeks, or months, depending on the nature and severity of the economic shock or shift.
Recognition lags occur for two main reasons: 1) because economic shocks, like any economic process, necessarily take time to play out, and 2) because it takes time to measure economic activity.
When an economic shock initially occurs, its full significance may not be apparent for some time until after its aftereffects have played out through the economy (or not). For example, if global oil prices rise sharply, it will take some time before the cost of this is passed on to consumers and businesses throughout the economy and for any resulting economic damage to occur. In addition, due to the inherent volatility, complexity, and uncertainty of economic processes and the human element involved, the exact effects of any given shock can never be fully predicted simply from the initial trigger.
To continue the example of an oil price spike, this may or may not result in any damage to the economy, for example, if the price quickly returns to its former level, if an alternative energy source is simultaneously developed to replace oil, or if market participants, businesses, and consumers across the economy can adequately hedge themselves against the risk of rising oil prices. In any of these cases, assuming that the oil price spike will lead to a major negative economic shock would be a mistake. You have to watch and wait.
Once these economic processes do begin to play out one way or another, it then takes time for analysts and government statistical agencies to gather, analyze, and communicate the relevant economic and market data to policymakers. Data documenting the state of the economy is not immediately available. It can take several months for important metrics to be collected and published, and then they must be analyzed and fully digested by the relevant shot callers.
There is no general consensus on the duration of recognition lag and the total lag in macroeconomic policy, but on average, a recognition lag is estimated between three and six months at a minimum. Reducing those timeframes would be virtually impossible given the inherent uncertainty of economic reality and that the economic variables that track business cycles are reported either monthly or quarterly, with a delay of a few months.
Moreover, monetary authorities may not react to reports immediately because initial estimates are often inaccurate or incomplete. Upward or downward movements in these figures are sometimes temporary, reversing during the next reporting period. This means additional time to correct, refine and interpret economic information is regularly required.
Example of Recognition Lag
During the Great Recession, it emerged that many European countries were saddled with huge government debts. Greece, in particular, was guilty of borrowing more money than it could make, although news of the country’s massive deficit did not come to light until 2010.
The recognition lag enabled the problem to spiral further out of control, putting at risk an entire continent and global trade flows.
Recognition Lag vs. Implementation Lag and Impact Lag
Recognition lag is studied in conjunction with other lags that follow it. They are:
- Implementation lag: the time it takes to implement a corrective fiscal or monetary policy response to an economic shock. Once they know what to do, a central bank authority is equipped to rapidly shift their policies. Policymakers usually meet every four to six weeks, although, in the event of an emergency, central banks can act even faster by calling an emergency meeting or even crafting policy via modern technologies such as the telephone and email without actually convening in person.
- Impact lag: the period between when monetary authorities change policy and when it takes full effect. This can potentially be the longest and most variable economic lag, lasting from three months to two years.
The entire process of identifying a problem, figuring out what action to take, and then waiting for corrective measures to take effect can be a long one, spanning anywhere between six months to three years. By that time, a country might be in a completely different economic condition.
The long lags can seriously hamper an active economy that might have recovered on its own and is currently facing a whole different set of pressures.