Rules vs. Discretion
ENDNOTES
1
They also used a floodplain example. See page 477 of Kydland and Prescott (1977).
2
See Simons (1936).
3
See Friedman (1960). He argued specifically for a rule restricting growth of the M2 measure of the money supply to 3 to 5 percent per year. Friedman did concede, however, that constraints on policy were more important than the numerical target range; so, this policy prescription is often characterized as a k-percent rule.
4
See Brennan and Buchanan (1981).
5
They noted that central banks with discretion have an incentive to renege on commitments to price stability. After the public has formed expectations of inflation, the central bank can increase monetary growth to reduce unemployment. The public will anticipate this possibility; so, in the end, inflation will be higher but unemployment will be no lower. Only a binding rule, Kydland and Prescott reasoned, can make the central bank’s commitment to price stability credible.
See Blinder (1998) for a discussion of the value of discretionary monetary policy expressed in the Kydland-Prescott framework.
7
Before the Federal Deposit Insurance Corp. Improvement Act of 1991 (FDICIA), bank supervisors had almost complete discretion over bank closings. Currently, supervisors have discretion over closings as long as capital ratios are above the prompt-correction-action thresholds set by FDICIA. When capital ratios fall below these thresholds, however, explicit supervisory responses are required. See Hall, King, Meyer and Vaughan (2002) for more details.
Blinder, Alan S. Central Banking in Theory and Practice. Cambridge,
Mass.: The MIT Press, 1998.
Brennan, H. Geoffrey and Buchanan, James M. Monopoly in Money and Inflation. London: Institute for International Affairs, 1981.
Friedman, Milton. A Program for Monetary Stability. New York: Fordham University Press, 1960.
Hall, John R.; King, Thomas B.; Meyer, Andrew P.; and Vaughan, Mark D. “Jumbo CDs Play Tiny Role in Policing Risky Banks—So Far. "Federal Reserve Bank of St. Louis The Regional Economist, July 2002, pp.12-13.
Kydland, Finn E. and Prescott, Edward C. “Rules Rather than Discretion: The Inconsistency of Optimal Plans.” Journal of Political Economy, Vol. 85, 1977, pp. 473-91.
Simons, Henry C. “Rules versus Authorities in Monetary Policy.” Journal of Political Economy, Vol. 44, 1936, pp. 1-30.