Working Paper: CEPR ID: DP2752
Authors: Bennett T. McCallum; Edward Nelson
Abstract: This Paper reviews the distinction between the timeless perspective and discretionary modes of monetary policymaking, the former representing rule-based policy as recently formalized by Woodford (1999b). In models with forward-looking expectations there is typically a second inefficiency from discretionary policymaking, besides the inflationary bias. The Paper presents calculations of the quantitative magnitude of this second inefficiency, using calibrated models of two prominent types; it examines the distinction between instrument rules and targeting rules; and briefly investigates operationality issues involving the unobservability of current output and the possibility that an incorrect concept of the natural-rate level of output is used by the policymaker.
Keywords: discretion; expectations; policymaking; rules
JEL Codes: E30; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| discretionary monetary policy (E60) | inefficiencies (D61) |
| discretionary monetary policy (E60) | looser policies than inflation target (E63) |
| commitment to timeless perspective policy (E60) | avoids inefficiencies (D61) |
| timeless perspective policy (F68) | aligns central bank's objectives with natural level of output (E61) |
| timeless perspective policy (F68) | enhances welfare outcomes (D60) |
| discretionary monetary policy (E60) | second inefficiency (H21) |