Rules vs. Discretion in Monetary Policy: From Commodity Money to Unconventional Monetary Policies

  •  Bogdan Badescu    


This paper proposes a review of the rules vs. discretion in monetary policy debate. Research shows that monetary regimes based on one or more rules had drawbacks, mainly due to the inflexibility imposed by these rules. Therefore, guiding monetary policy strictly by a set of rules is not the optimal approach. The late twentieth and early twenty-first centuries were characterized by a relaxation of the regulations in force, which led in 2008 to one of the worst economic crisis. Since the efficiency and correctness of the measures taken by the authorities as a response to the crisis are questionable and also that their long-term effects (especially the redistribution of wealth) and how to exit from them are still unknown, it becomes clear that a purely discretionary approach is not desirable either. Consequently, it should be implemented a more restrictive approach in terms of the discretionary component embedded in the authorities' decision. A starting point might be to increase the transparency regarding, for example, the algorithm by which the central banks set the policy rate or decide to increase the monetary base. In this sense, for central banks managing reserve currencies could be established publicly announced rules that govern the issuance of money and the policy rate. Moreover, such measures must be combined with improving the regulations in force, so that the attention will be also geared towards the microeconomic level, where it is most important to maintain financial stability. Last, but not least, it is important to remember that this stability should come as a result of the improvement of the general welfare, as the architects of the old Bretton Woods system envisioned.

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