● Firms make investment plans in advance, so I takes time to

respond to changes in r

● Most economists believe it takes at least 6 months for monetary

policy to affect output and employment

■ Fiscal policy also works with a long lag:

● Changes in G and T require acts of Congress

● Legislative process can take months or years

■ Due to these long lags

● Critics of active policy argue that such policies may destabilize the

economy rather than help it

● By the time the policies affect aggregate demand, the economy’s

condition may have changed

● Contend that policymakers should focus on long-run goals like

economic growth and low inflation

■ When Congress cuts taxes

● Should consider short-run effects on aggregate demand and

employment

● And the long-run effects on saving and growth

■ When the Fed reduces the rate of money growth

● Must take into account not only long-run effects on inflation

● But the short-run effects on output and employment

Theory of Liquidity Preference

● According to the liquidity preference theory, investors prefer to keep their money liquid

-- or as cash -- and they demand interest in return for sacrificing this