Monetary Policy Rules Work and Discretion Doesn’t: A Tale of Two Eras

Thursday, March 1, 2012

Economics Working Paper WP12105

Thirty years ago Milton Friedman delivered the Journal of Money, Credit and Banking Lecture. He began by reiterating that “the long-run objective of monetary policy must be price stability” and then focused on what he called the “fundamental issue…Rules versus Authorities….Should the tactics” for setting the instruments of monetary policy, he asked, “be determined by relatively mechanical rules that are publicly promulgated, or by the discretion of authorizes instructed to follow the right policy at the right time for the right objective?” By empirically examining monetary policy during the seven decades from the founding of the Fed until around the time of his lecture, Friedman concluded that “the discretion of authorities” was severely deficient and recommended a predictable rules-based approach to monetary policy.

Monetary Policy Rules Work and Discretion Doesn’t: A Tale of Two Eras