Working Paper: NBER ID: w2770
Authors: Robert Flood; Peter Isard
Abstract: The paper considers the merits of rules and discretion for monetary policy when the structure of the macroeconomic model and the probability distributions of disturbances are not well defined. It is argued that when it is costly to delay policy reactions to seldom-experienced shocks until formal algorithmic learning has been accomplished, and when time consistency problems are significant, a mixed strategy that combines a simple verifiable rule with discretion is attractive. The paper also discusses mechanisms for mitigating credibility problems and emphasizes that arguments against various types of simple rules lost their force under a mixed strategy.
Keywords: Monetary Policy; Credibility; Rules and Discretion
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| mixed strategy (C73) | expected social loss (P27) |
| delaying policy reactions (E63) | expected social loss (P27) |
| optimal nonstate-contingent rule (H21) | expected losses (G33) |
| choice of monetary rule (E60) | social welfare (I38) |
| increased variance of productivity shocks (O49) | attractiveness of discretion (D91) |