Rule-based and discretionary macro economic policy pdf

It draws on but goes beyond the entries in the forthcoming oxford companion to the economics of south africa. In addition to this lack of timeliness, discretionary fiscal policy adjustments have shown two types of asymmetries that have undermined the sustainability of public finances. Kydland and prescott 1977 showed that rulebased policymaking can increase. There are two major policy instruments available for influencing the economy. The rise of discretionary policies first consider the rise of discretionary macroeconomic policies in the post world war ii period, a story which is well known so i can be brief. This rule allows a policy response to the flood, thereby making it activist in nature, but that response is predefined.

Lower federal borrowing reduces interest rates directly, by reducing demand for credit. Another premise behind many rulebased policy prescriptions, however, is that our knowledge of the full workings of the system is quite limited. A decrease in taxation will lead to people having more money and consuming more. However, it can also lead to inflation because of the higher demand within the economy. A stabilization policy is a macroeconomic strategy enacted by governments and central banks to keep economic growth stable, along with price levels and unemployment. For instance, a central banker could make decisions on interest rates on a casebycase basis instead of allowing a set rule, such as friedmans kpercent rule. A discussion on thematic theoretical and empirical literature on is provided in section 2 after the introduction. Rules versus discretion in monetary policy stanley fischer. First, to the extent that the deep parameters describing preferences and constraints are approximated reasonably well, the theory can provide reliable predictions over any number of hypothetical policy. Glasner, david, rules versus discretion in monetary policy historically. The other leading argument concerns the economys performance under rules and under discretion that is, the economic implications of committing policy. Explains general short and longrun effects of fiscal policy during a recession. A fixedrule policy, by definition, is pursued no matter the condition of the economy, and. Some macroeconomists thus have argued in recent years that monetary policy should be rulebased rather than discretionary, that is, central bankers strictly would have to follow some kind of monetary policy rule without the authority to deviate.

Some policy rules can be imposed by external bodies, for instance, the exchange rate mechanism for currency. The debate of rules versus discretion in economic policy has its origin in the writings of henry simons at the university of chicago. In particular i want to discuss the fundamental policy issue of rules versus discretion. The aim of the article is to solve dilemmas about the positive and negative consequences of strict regulations of contemporary fiscal policy.

Macroeconomic variables can then be computed by summing up the actions of all individuals. Discretionary fiscal policy as a stabilization policy tool. A fiscal or monetary policy designed to be an economic goal or target of a government. House republicans have introduced bills that would require the federal reserve to follow a. The general conclusion discussed in section 5 is that the rules versus discretion debate is an issue of political economy concerned with the institutions of policy making and the scope for macroeconomic policy. Henry simons 1936 first raised this issue as a choice between rules and authorities, terms little different than those used in recent discussions. In this video i explain the basics of fiscal policy and the difference between non discretionary and discretionary fiscal policy. Thus, the research showed that rulesbased monetary policy would lead to good macroeconomic performance in the national economy and in the. Historical evidence on the benefits of rulesbased economic policies. Section 3 focuses on macroeconomic policy, including fiscal, monetary and exchange rate policy. Hould monetary policy be determined by a legislated rule or by a monetary authoritys discretion. Over the past two decades, the demand to establish fiscal discipline has gradually been increasing both in literature and in economic policy decisions. Fiscal policy can be of a discretionary or rulebased nature.

Monetary policy refers to the federal reserve banks mandate to influence the economy by manipulating currency levels and the amount of treasury securities on the market, which in turn affects interest rates. This article discuses selected examplesof fiscal rules as well as presents the advantages and disadvantages of following them. Discretionary monetary policy produces a dynamic loss in the new. A more prudent fiscal policy reduces the likelihood that the federal reserve will need to pursue a restrictive monetary policy, and so reduces expected future shortterm rates.

Premised on the dynamics of expanding labor market in nigeria and by juxtaposing the labor market and macroeconomic policies in the country, the study examines the contradictions and challenges facing the realization of the goals of gainful and productive employment in. Economic fluctuations and growth, monetary economics this paper examines the case for rules rather than discretion in the conduct of monetary policy, from both historical and analytic perspectives. It helps to overcome not only the traditional ination bias in the sense of barro and gordon. Pdf u rules and discretion in monetary policy semantic. The paper revisits the link between fiscal policy and macroeconomic stability.

In macroeconomics, discretionary policy is an economic policy based on the ad hoc judgment of policymakers as opposed to policy set by predetermined rules. Inflation uncertainty, disagreement and monetary policy heidelberg. For the practitioner i most of you are going to have jobs in which you have to take decisions a ecting others. Republican presidential candidate ted cruz expressed his deep passion for implementing a monetary policy rule in a handful of presidential debates this year, including both octobers and novembers debates. The three main types of government macroeconomic policies are fiscal policy, monetary policy and supplyside policies. In the monetary realm, failures to stick to quantitative limits on the growth of monetary aggregates in. Other government policies including industrial, competition and environmental policies. Deliberate changes in government spending and taxation explain counter cyclical policies.

The application of economic laws to improve economic conditions or to avoid economic downturn is called discretionary policy. He stresses the value of a rule, such as a law, instead of reliance on an authoritys discretion because definite, stable, legislative rules. Kydland and prescott 1977 showed that rulebased policymaking can increase welfare. Rules versus discretion in monetary policy historically contemplated. The first tool is the discretionary portion of the u. Thus, discretionary fiscal policies have frequently been procyclical, overriding automatic stabilisers and possibly contributing to economic instability. He concludes that a rulebased approach is superior and may have been able to prevent the 20082009 financial. Rules versus discretion in monetary policy historically. Fiscal policy definitions fiscal policy is the use of taxes, government transfers, or government purchases of goods and services to shift the aggregate demand curve.

Fiscal policy pertains to governments ability to control expenditures and assess taxes. The timeless perspective proposed by woodford 1999 represents a prominent modern form of such a rule in monetary policy analysis. August 29, 2016 1 introduction over the past forty years, a broad consensus has developed. Goals of economic policy boundless political science. The existing estimates are mostly based on expenditureside series, such as. This should also create an increase in aggregate demand and could lead to higher economic growth. Economic report of the president 1994 washington, dc. Fiscal policy and macroeconomic stability international monetary.

An introduction to monetary policy rules mercatus center. The phrase rulesbased monetary policy has frequented conservative circles a lot lately. Institutional and rulebased constraints of discretionary budgetary policy over the past two decades, the demand to establish fiscal discip line has gradually been increasing both in literat ure. A rulebased policy can be more credible because it is more transparent and easier to anticipate, unlike discretionary policy. An expansionary discretionary fiscal policy is typically used during a recession. Discretionary monetary policy refers to the feds ability to react dynamically to economic conditions. A compromise between strict discretionary and strict rulebased policy is to grant discretionary power to an independent body. Can a rulebased monetary policy framework work in a. The article discusses the fundamental principles of macroeconomic policy. A clear policy rule commitment would bind the fed to a future course of action based on clearly defined economic outcomes, thus drastically reducing uncertainty with respect to future policy. A formal policy frameworkproactive, rulebased, and with a greater direct focus on inflationis needed to guide the central bank in the conduct of monetary policy in the context of a more flexible exchange rate and continued free capital mobility.

Monetary theory and the struggle with discretion versus. Keynesian ideas about countercyclical fiscal policy grew in popularity in academia in the 1950s and 1960s and were soon applied to actual policy. The articles analysis outlines some suggestions and recommendations, which are based on the adherence to clearly defined rules in fiscal policies and focuses. The impact of national fiscal rules on the stabilisation function of.

They also discuss the factors underlying ex post revisions of fiscal indicators. Section 2 begins with a broad account of the evolution of the economy since 1994. A strict rulesbased approach does not allow for flexibility and as a result may limit choices or be inapplicable in certain circumstances, creating a need for a compromise between discretionary and rulesbased policy. Why congress should institute rulesbased monetary policy. Fiscal and monetary policy what we do and dont know about discretionary fiscal policy, by renee courtois, federal reserve bank of richmond economic brief, april 2009, eb0904. Identifying relationship between macroeconomic and fiscal. For instance, the federal reserve bank, european central bank, bank of england and reserve bank of australia all set interest rates without government interference, but do. Here you are going to learn critical insights about a wide range of economic policies taxes, education policies, social.

A policy rule can be specific as fixing the quantity of currency and demand deposits, or general as when the federal reserve announces to the public the course of action it will take for various states of the economy, putting its reputation behind it. The two typical solutions for constraining discretionary budgetary policy are introducing fiscal. Countercyclical policies aim to move demand in the opposite direction to the economic cycle eg increases in public spending in slumps list the strengths of fiscal policy. It traces the development of macroeconomic policy ideas, and, particularly, the transition cycle from adhering to strictly defined rules to free discretion and vice versa back to restricting the freedom of implementation of macroeconomic policy instruments. I epa is the toolkit to understanding social choices i some of you may well end up working forin a public administration. Congress determines this type of spending with appropriations bills each year. Section 3 presents stylized facts about the fiscal policy regime in india. Households will spend less due to availability of less discretionary income, expensive borrowing and greater incentive to save. Mercatus working paper, mercatus center at george mason university, arlington, va, november 2014. Fiscal indicators in a rulebased framework by robert.