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Discretionary policy & time inconsistency

Should macroeconomic policy be discretionary or rule based? You may illustrate your answer with a formal model.

Carl E. Walsh, Monetary Theory and Policy, Second Edition, 2003.

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Should macroeconomic policy be discretionary or rule based? You may illustrate your answer with a formal model.

In my opinion, the macro economic policy should be rule based but have some basis for discretion. The reason are that a rule based policy is more plausible, is easier to foresee, and is transparent. A rules based policy can also be developed and implemented by specialized bodies. On the other hand a discretionary policy allows policy makers to be flexible and more responsive. Typically a discretionary policy reacts to pressures of inflation. This brings about a level of unpredictability of the monetary policy. For instance, the government may decide to keep the cash reserve ratio high to control inflation but later lower the CRR.
Currently, in most cases it is very difficult to set perfectly discretionary policies because external interventions by lending banks like the World Bank or the IMF. An important role of the discretionary policy is to complement the fiscal policy so that the country may tide over the challenges of the business cycle.
Rules based macroeconomic policies make assumptions about how the economic policies work. The rules based polices are based on the model that the cause effect connections ...

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