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May/June 1993, 
Vol. 75, No. 3
Posted 1993-05-01

Rules and Discretion in Monetary Policy

by Gerald P. Dwyer, Jr.

Should monetary policy be determined by a legislated rule or by a monetary authority’s discretion? Henry Simons first raised this issue in 1936 as a choice between rules and authorities, terms little different from those used in recent discussions. Proposed rules would restrict the Federal Reserve's discretion in various ways. Simons argued that the Federal Reserve should be required to keep the price level constant. Some other proposed rules embody far more radical changes in the U.S. monetary system. This article provides an overview of the debate on rules vs. discretion. Dwyer focuses on the following basic issue: Even if policy actions would usually be the same with or without a rule, what are the benefits and costs of a rule that commits policy? On the benefit side, rules make it possible to have policies that are otherwise impossible. On the cost side, rules can limit a monetary authority's responses to the economy’s recent performance. As Dwyer indicates, though, such responses can actually be destabilizing, and evidence that such responses have been stabilizing is lacking.