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In monetary policy, discretionary policymaking corresponds to the central bank seeking to influence or respond to momentary fluctuations in unemployment and inflation without a long-term strategy. However, the line of demarcation between rules and discretion is difficult to establish in practice which makes contrasting the two approaches difficult. Simons’s student Milton Friedman revived Simons’s argument against discretion and modified Simons plan for 100-percent reserve banking and a constant money supply into his k-percent rule for monetary growth. Misconceptions regarding rules vs. discretion for monetary policy. For example, suppose the Federal Reserve implements an easy money policy to reduce interest rates, expand investment spending and boost real GDP. Open loop rules versus closed loop rules: a debate about the appro-priate formulation of policy rules. Discretionary monetary policy has long been an anomaly to liberal economists. Copyright © 1990 Published by Elsevier B.V. https://doi.org/10.1016/S1573-4498(05)80028-1. Hence, the private agents are never worse off under discretion than under a rule, and this may provide some explanation of why discretionary powers are granted to monetary authorities. With all goods traded and their prices equalized worldwide, adjustment comes purely through wealth effects as the outflow of gold from a country with a current account deficit reduces the flow of spending in that country. Rules derived from research help central bankers formulate monetary policy as they operate in domestic financial markets and the global monetary system. DISCRETION. ScienceDirect ® is a registered trademark of Elsevier B.V. ScienceDirect ® is a registered trademark of Elsevier B.V. Chapter 21 Rules versus discretion in monetary policy. 2. 3 Rules vs. Prescott’s contribution to the rules vs. discretion debate was to show that dis-cretionary policy can produce undesirable long-run outcomes—in the monetary-policy case, higher inflation with no reduction in unemployment—even in a world with little uncertainty, good policy tools and public-spirited policy-makers.5 Must It Be a Rule? Published By: Palgrave Macmillan Journals. This policy helps to create flexibility and allows for creation of adjustments as situations occur. In contrast, discretion leads to an inflationary bias in monetary policy … The idea of ‘rule-based’ monetary policy is actually relatively old. Rules Vs Discretion 1. For terms and use, please refer to our Terms and Conditions Opposed to using a strict rule based monetary policy, using discretion has many advantages of its own. Under pure discretion, the set- Discretion ** Parts of this entry have been adapted from a post on rules vs. discretion by Jason Buol and Mark Vaughan, published by the Federal Reserve Bank of St. Louis. The modern literature centered on the concept of dynamic inconsistency and its relevance to the rules versus discretion debate is discussed in the chapter. Did Government “indiscretion” cause the financial crisis? I am grateful to Olivier Blanchard, Ben Friedman and Milton Friedman for helpful comments, and the National Science Foundation for research support. We all agreed that a rule-based system would be a major improvement on the existing system. One of the most important contributions to this … Palgrave Macmillan is a global academic publisher, serving learning and scholarship in higher education and the professional world. The Taylor Rule is an interest rate forecasting model invented by famed economist John Taylor in 1992 and outlined in his 1993 study, "Discretion Versus Policy Rules in … Rules vs discretion_d25aa00fdff38521b84d47dc746d9956.pdf from ECO 305 at The Chinese University of Hong Kong. Discretionary monetary policy is a more flexible approach whereby central bankers at the Fed can quickly react to changing factors to tweak the economy, especially in an unusual situation. Ch. The pre-1977 arguments of principle for rules lacked any convincing demonstration that rules might systematically be better than discretion. The discussions raised a huge number of interesting ideas, among which was the question of rules vs. discretion in monetary policy. ECO305 Lecture 10. In this case, the application of rules for monetary policy seems increasingly pragmatic because the rule only works to limit monetary authorities from exercising unsanctioned judgments (Arnold 491). ©2000-2020 ITHAKA. JSTOR®, the JSTOR logo, JPASS®, Artstor®, Reveal Digital™ and ITHAKA® are registered trademarks of ITHAKA. In order to get it right, it helps to follow a rules-based policy instead of one based on discretion. ... Monetary Policy: Rules vs. Recognizing the potential drawbacks of purely discretionary policy, the Federal Reserve frequently has sought to exploit past patterns and regularities to operate in a systematic way. The debate about rules vs. discretion in monetary policy has a long and interesting history, summarized by Argy (1988) and Carlson (1988). Discretion . Conversely, monetarists propose a tight, fixed rule to ensure price stability. Monetary policy, rules vs. discretion, and some thoughts about the Taylor rule. ifthegovernmenthasfull“discretion” (freedomtochooseˇ)andlittle“internalcommitment”,then the economy ends up in a high-inflation trap. Monetary policy refers to the Federal Reserve's work with the money supply to influence the economy. The specie-flow mechanism in which the money stock adjusts through the balance of payments reveals the equilibrating tendencies inherent in the system. The current monetary regime in the UK, and many other major economies, is known as flexible inflation targeting. Until 1977 the general argument for monetary rules suffered from the apparent dominance of discretion: if a particular monetary policy was desirable, it could always 09 adopted by discretion. The monetary policy of the Federal Reserve has involved varying degrees of rule- and discretionary-based modes of operation over time. 2.1 Rules vs. Author: ... because of their reports that Alan Greenspan had come out clearly in opposition to the adoption of any monetary policy rule for the Fed. Discretion Revisited: A Proposal to Make the Strategy of Monetary Policy Transparent Robert L. Hetzel Knut Wicksell (1978, 3) said a hundred years ago in his Lectures on Political Economy, “With regard to money, everything is determined by human beings themselves, i.e. Eastern Economic Journal We aim to do this by reaching the maximum readership with works of the highest quality. Rules vs. We publish textbooks, journals, monographs, professional and reference works in print and online. We use cookies to help provide and enhance our service and tailor content and ads. Therefore, a rule that commits the monetary authority to a nonactivist, nondiscretionary policy makes the economy more stable by creating a more credible, more certain policy aimed at price stability [Barro and Gordon, 1983a]. View Lecture 10. However, perhaps the most debated monetary policy rule in the last decade was suggested by John Taylor himself in 1992, the Taylor rule. As part of the Macmillan Group, we represent an unbroken tradition of 150 years of independent academic publishing, continually reinventing itself for the future. A pure gold standard is a fully automatic monetary system. By continuing you agree to the use of cookies. Request Permissions. There is also substantial litera-ture on the implementation of monetary policy and the im-plications for rules, much of it in this Review Goodhart (1989) presents a detailed analysis of the implementation of They conclude that an easy or tight money policy will alter the rate of inflation but not real output. RULES VS. Proponents of central bank discretion argue that a simple monetary policy rule is incompatible with the complexity of … 3. monetary policy rules can be applied in a practical policymaking environment. Discretion with John B. Taylor: Perspectives on Policy - Duration: 4:59. This demonstration came with the dynamic inconsistency literature. Our programme focuses on the Humanities, the Social Sciences and Business. ... to lose the concept of a policy rule entirely. The Eastern Economic Journal, a quarterly publication of the Eastern Economic Association, was established in 1973. Discretion was described, as giving a monetary authority the power to act in accordance with its own judgment. Rules-based monetary policy gives a central bank a strict set of guidelines that dictate its future actions. In fact, strategic responses of rational, utility-maximising agents lead to an ex-post sub-optimal arrangement; rules ensure that – ex-post – at l… This paper examines the doctrinal and ideological origins and background that lay behind the rules versus discretion distinction. According to this research, good policy rules typically call for changes in the federal funds rate in response to changes in the price level or changes in real income. JSTOR is part of ITHAKA, a not-for-profit organization helping the academic community use digital technologies to preserve the scholarly record and to advance research and teaching in sustainable ways. Academics and policymakers debate whether central banks should follow a predetermined, fixed rule or should have discretion in monetary policy. Monetary policy is often only noticeable when the Federal Reserve gets it wrong, as it has several times in recent history. the statesmen, and analyzed in the context of the Taylor rule. The next section explores these … Rules versus discretion: a debate about the exercise of judgment in economic policy making. © 2000 Palgrave Macmillan Journals In a recent essay, “Monetary Policy Rules Work and Discretion Doesn’t: A Tale of Two Eras,” Taylor (2012a) identifies the late 1960s and 1970s as a period of discretionary policy, 1980 to 1984 as a transition, 1985 to 2003 as the rules-based era, and 2003 – 2012 (and possibly The debate over “rules vs. discretion” was a centerpiece of disputes over monetary policy during the 1960s-1980s. When this is the case, there is value for rules over discretion, for constitutional constraints on the conduct of monetary (and fiscal) policies, or for other ways to tie the government’s hands. 8/31/2014 ... Central Bankers strictly would have to follow some kind of monetary policy rule without the authority to deviate from it. Our goal is to be publisher of choice for all our stakeholders – for authors, customers, business partners, the academic communities we serve and the staff who work for us. public observes policy-makers and forms expectations of their likely actions All Rights Reserved. Published on: November 25, 2019 Sound monetary policy is essential for strong economic growth and stability. In monetary policy, discretion is essential to offset output fluctuations in Keynesian frameworks. The time-(in)consistency literature, launched bu Kydland and Prescott (1977), shows that discretion-based solutions would be the first-best in terms of agents’ utility, but they are not time-consistent. 174 T.M. The EEJ publishes papers written from every perspective, in all areas of economics and is committed to free and open intellectual inquiry from diverse philosophical perspectives. 21: Rules Versus Discretion in Monetary Policy 1159 nonetheless severely critical of the Bank's misuse of its discretionary powers. Sound monetary policy is essential for strong economic growth and stability. of fiscal and monetary policy swings. This item is part of JSTOR collection The Taylor Rule and the Fed Funds Rate Target - Duration: 16:15. Copyright © 2020 Elsevier B.V. or its licensors or contributors. Discussion Questions: Why has discretionary Generally New Classical rational expectations economists also support a monetary rule. Henry Simons addressed the issue in his classic paper “Rules versus Authorities in Monetary Policy.” This chapter discusses the gold standard as a quasi-automatic monetary policy regime and alternative monetary rules are also examined. 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