Monetary policy affects the economy with a long lag, in part because:

• A. monetary policy only impacts the economy during periods of hyperinflation
• B. the government immediately adjusts fiscal policy in response to monetary changes
• C. consumers instantly react to changes in the money supply
• D. changes in interest rates take time to influence spending and investment decisions

Answer: (D)

Verified step by step guidance

1. Understand that monetary policy primarily works through influencing interest rates, which then affect spending and investment decisions in the economy.
2. Recognize that changes in interest rates do not immediately translate into changes in economic activity because businesses and consumers take time to adjust their behavior.
3. Consider the transmission mechanism of monetary policy: when the central bank changes the money supply, it affects interest rates, which then influence borrowing costs and incentives to spend or invest.
4. Acknowledge that this process involves decision-making delays, contract adjustments, and gradual changes in consumption and investment plans, leading to a lagged effect on the overall economy.
5. Conclude that the lag in monetary policy effectiveness is due to the time it takes for interest rate changes to permeate through spending and investment decisions, rather than immediate or direct impacts.