What it means
Imagine standing under a shower where the water reacts a minute after you touch the tap. You feel it is too cold, so you turn the tap to hot and then further still, and by the time the scalding water arrives you swing the tap back too far.
The mistake was not the goal of a comfortable temperature, but the failure to allow for the delay. Economists use this picture to describe monetary policy, which is the control of interest rates and the money supply by a central bank.
Changes to rates take time to filter through to borrowing, spending, hiring and prices, and the delay is often described as long and variable. If policymakers keep reacting to today's data without allowing for the lag, they may fuel a boom or deepen a slump.
The metaphor is often linked to the economist Milton Friedman, who argued that lags make it dangerous to fine-tune an economy through frequent policy changes. His preferred answer was to follow steady, predictable rules instead.
Others disagree and believe skilled policymakers can allow for the lags by looking ahead at forecasts, which is how most central banks describe their approach today. For business leaders, the lesson is practical.
Central bank decisions made now will affect borrowing costs and demand over the following months, so the full effect of a rate rise or cut may not be visible in the first quarter. Treasurers and CFOs should plan using a range of scenarios rather than assuming that today's economy shows the final result.
The same logic applies inside companies. A manager who cuts prices, then raises them, then cuts them again because sales have not responded immediately is behaving like the fool in the shower.
Changes to pricing, hiring and marketing all take time to show their results. The remedy is patience and good measurement.
Make a change, set a review date that allows for the delay, and look at leading indicators such as enquiries and orders before reversing course. A written review date also makes it easier to resist pressure from colleagues who want immediate action.
In practice
Real-world examples.
Example
A central bank raises interest rates and, seeing inflation still high two months later, raises them again. Critics argue that the first rise had not yet worked through to borrowing, so the second risks pushing the economy into a sharper slowdown than was needed.
Example
A retailer lowers prices after one weak week of sales, then lowers them again the next week. Customers eventually respond, but by then the retailer has sold stock at far lower margins than it needed to, and it has taught shoppers to wait for the next sale.
Example
A start-up founder changes the marketing plan every fortnight because leads have not yet improved. The sales cycle is 90 days, so none of the changes had a chance to show results, and the team can no longer tell which idea worked.
Case study
Seen in the real world.
Cobalt Bay Hardware is an illustrative, fictional retail chain whose finance director noticed that the company changed its discount strategy almost every month. Each time sales dipped, the sales team increased discounts, then cut them again when the margin report arrived.
An analysis showed that customers took roughly eight weeks to respond to a change in promotions. The team had been making a second and third change before the first had worked, so results looked random.
The company adopted a rule of keeping each promotion in place for ten weeks unless there was a clear emergency, and it reviewed enquiries and basket sizes weekly without changing anything. Sales became steadier and margins improved, and the illustrative lesson was that waiting for a change to work can be the most active decision.
Watch out
Common mistakes.
- Judging a policy or business change on its first few weeks of results, when its effects may take months to appear.
- Assuming the metaphor says policymakers should never act, when it only warns against reacting repeatedly without allowing for the delay between action and effect.
- Treating it as a precise economic law, when it is a simple picture to explain lags and carries no formula or fixed time delay.
Questions
People also ask.
Who is associated with this metaphor?
It is often linked to Milton Friedman's arguments about the long and variable lags of monetary policy, although similar ideas appear in many economics courses.
Why do monetary policy lags exist?
Households and firms take time to change borrowing, spending and pricing decisions after rates move.
How can a business avoid being a fool in the shower?
Set a review date that allows for the likely delay, track leading indicators and avoid changing several things at once.
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