Working Paper: CEPR ID: DP15976
Authors: Harris Dellas; George Tavlas
Abstract: We discuss the evolution of the debate on policy rules vs discretion. Doctrinal historians place the starting point of the debate in the nineteenth-century controversy between the Currency and Banking Schools in Britain. We establish that this controversy was not about discretion but about the degree of activism under a single rule -- that of the gold standard. The rules vs discretion issue originated with Henry Simons and the Chicago School in the 1930s, and came to center stage following the Great Inflation in the 1970s. Both the 1930s and 1970s literatures were triggered by monetary-policy failures. The modern literature’s main innovations concern its (1) comparison of discretion to optimal policy rather than just to rules, (2) shift of focus to benevolent governments that lack commitment, (3) demonstration of discretion’s inefficiencies in both stochastic and deterministic environments, and (4) support of activistic policy rules.
Keywords: rules versus discretion; monetary policy; modern debate; Chicago School; currency school; banking school
JEL Codes: B22; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Discretion in monetary policy (E60) | economic instability (E32) |
| Discretion in monetary policy (E60) | uncertainty in economic outcomes (D89) |
| Adoption of monetary rules (E42) | reduction of uncertainty in economic outcomes (D89) |
| Discretion in monetary policy (E60) | inflation biases (E31) |
| Adoption of rules (e.g., Taylor rule) (E61) | improvement in economic stability (E63) |
| Historical monetary policy failures (1930s and 1970s) (E65) | reevaluation of policy approaches (E65) |
| Discretion in monetary policy (E60) | unpredictable outcomes (D80) |