Milton Friedman famously said, “monetary changes have their effect only after a considerable lag and over a long period and that the lag is rather variable.” This lingo has infected macroeconomic discourse and the speeches of Federal Reserve officials. In 1996, Alan Greenspan said, “Because monetary policy works with a lag, we need to be forward- looking.” Jerome Powell often refers to the lags associated with monetary policy as well, like in this 2022 press conference, where he said, “monetary policy works with ‘long and variable lags,’” clearly a reference to Friedman’s original quote.
In the press conference, Powell admits that the consensus regarding the length of the lags is changing: “There was an old literature that made those lags out to be fairly long. There’s newer literature that says that they’re shorter.”
What Friedman, Greenspan, and Powell have in mind is the statistical relationship between changes in the money supply or interest rates and the measured response in unemployment, economic growth, or price indexes. But any estimated lag using this data is a mere artifact of aggregation. It’s obvious that a new influx of money will not immediately bring about changes in enough prices to significantly alter a price index, even if we ignore the lags associated with the data collection, calculation, and publishing of price indexes. Even so, there are immediate effects of the new money. As any counterfeiter can tell you, he is able to outbid other buyers immediately. The prices of the goods bought by the counterfeiter increase first, and then the subsequent receivers of the new money can outbid others.
In this way, changes in the money relation immediately start a process that only eventually manifests as measured outcomes in aggregate statistics. Thinking about monetary policy in terms of lags ignores the processes that bring about the lagged “result.” In truth, there is no single “result” apart from the step-by-step Cantillon-effect process, which includes both intended and unintended consequences (like starting a business cycle). It’s reductive to fixate on a lagged change in the measured price level or the unemployment rate—in so doing, the central bank is blind to the problems they create.
