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March/April 2004, 
Vol. 86, No. 2
Posted 2004-03-01

Timeless Perspective vs. Discretionary Monetary Policy in Forward-Looking Models

by Bennett T. McCallum and Edward Nelson

The authors first review the distinction between the timeless perspective and discretionary modes of monetary policymaking, the former representing rule-based policy as formalized by Woodford (1999). This distinction becomes important in models with forward-looking expectations, a model feature that was not typically used in the rules-vs.-discretion literature. In addition, the authors examine the distinction between instrument rules and targeting rules. Their results indicate that targeting-rule outcomes can be closely approximated by instrument rules that respond to any failure of the targeting rule’s optimality condition to hold. Using the instrument rule formulation, the briefly investigate operationality issues, involving the unobservability of current output and perhaps inflation. In addition, they examine a set of cases that assume that the monetary policymaker is using the wrong concept of the natural rate or potential level of output. In almost all of the various cases examined in the article, the performance of timeless-perspective policymaking is at least as good as that provided by optimal discretionary behavior. Furthermore, these optimal rules can be well approximated by simple feedback rules based on an interest rate instrument.