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June 2010 issue
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Sauer
Baeriswyl, Cornand
Bikker, Broeders, de Dreu
Pavasuthipaisit
Andersson
De Santis
Catalão-Lopes
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Discretion Rather Than Rules? When Is Discretionary Policymaking Better Than the Timeless Perspective?

by Stephan Sauer
European Central Bank

Abstract

Discretionary monetary policy produces a dynamic loss in the New Keynesian model in the presence of cost-push shocks. The possibility to commit to a specific policy rule can increase welfare. A number of authors since Woodford (1999) have argued in favor of a timeless-perspective rule as an optimal policy. The short-run costs associated with the timeless perspective are neglected in general, however. Rigid prices, relatively impatient households, a high preference of policymakers for output stabilization, and a deviation from the steady state all worsen the performance of the timeless-perspective rule and can make it inferior to discretion.

JEL Codes: E5.

 
Full article (PDF, 29 pages 599 kb)