The Optimal Degree of Discretion in Monetary Policy

By Susan Athey, Andrew Atkeson, Patrick J. Kehoe. Social Science Research Network, 2004

191 citations recorded by the source corpus.

How much discretion should the monetary authority have in setting its policy? This question is analyzed in an economy with an agreed-upon social welfare function that depends on the economy's randomly fluctuating state. The monetary authority has private information about that state. Well designed rules trade off society's desire to give the monetary authority discretion to react to its private information against society's need to prevent that authority from giving in to the temptation to stimulate the economy with unexpected inflation, the time inconsistency problem. Although this dynamic mechanism design problem seems complex, its solution is simple: legislate an inflation cap. The optimal degree of monetary policy discretion turns out to shrink as the severity of the time inconsistency problem increases relative to the importance of private information. In an economy with a severe time inconsistency problem and unimportant private information, the optimal degree of discretion is none.

Subfields: Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/131ca918e1505c0c55d9c47e9eadc0fd5ecbf430

Citations in the corpus

• Fiscal Rules and Discretion under Persistent Shocks (2012, unknown): “Most closely related is Azzimonti, Battaglini, and Coate (2010), who consider the quantitative welfare implications of a balanced budget rule in an i.”