Should monetary policy be made by rule rather than by discreation(macroeconomic) - Essay Example

Monetary Policy –Rule or Discretion Introduction: The advents of monetary policies by the Central Bank, and Federal Reserve Banks, had been and have been a successful process for determining the economic stability of big nations in the world filled with competencies. Meanwhile the monetary policies enhance the financial monopolies of the respective countries. For the past few years, several controversies are spreading regarding whether monetary policies should either be considered as rules or as discretion.

The many economists debate between rule and discretionary monetary policies has given different forms of opinions among the economists.Monetary Policy as a rule and as discretion: Both the rules and discretion need to be analysed in terms of the stability in economy and the inflation targets. While rules determine the inflation sequence, discretion determines the full employment that is lacks in rules. Rules, however maintains the inflation in a statistical fashion, and helps in operating the economy in a definite and expected way.

Economists supporting rules argue that the Central Bank will work independently without the political influences, where as those who raise hands for discretion argues that the increasing rate of interest and unemployment will be monitored can controlled by discretion. As a result, the Federal will meet a circumstance to work freely within the given allocations. Explanation: The central banks consider rules as inflexible but at the same time rules will eliminate the mistakes, by demanding the Central Bank to work within the policy requirements.

Where as the discretion based policy will enable the Federal Reserve Bank to act will full freedom within the given limit. In the case of rule, based monetary policies the rate of unemployment and the inflation remains linked in a statistical proportion and the rules will lead to high inflation rates that in turn will result in increase in unemployment. Though some supporters favour employment productivity, their main target seems to be fixed towards increasing production and distribution to continue with a economic growth rather than improving the labour market.

Milton Friedman supports a rules based policy, because he stresses on the point that rules will have a constant growth of money. Friedman [1968] argues that a discretion based monetary policy will put efforts to bring out less inflation rates and full employment, but this will consequently result in increase in inflation rates and unemployment as well. The rules advocated by Friedman [1968, 1972, 1992] was aimed at balancing the stability in accordance with the production level. The inflation rates is considered as the target for all the federal and central authorities, in such a condition a discretion policy could possible work on only a specific rule or policy, which could be argued again as an illusionary freedom given for the Federal Reserve Bank, where as rules allows the Central Banks to act freely within the circumstances.

This appears to be better than that of the discretion based policy. The famous economist like Goodfriend [1997] argues that discretion will lead to instability in inflation, which will consequently lead to economic disturbance and undemocratic outlook. He rather administers the fact that economic stability could be attained easily through legislation [ again stressing on rule based monetary policies].Conclusion: While analysing the different views over the rule and discretion based monetary policies, it becomes quiet clear that inflation rates play a dominant role in determining the economic stability of the Central Bank and the Federal banks, but a discretion-based policy will restrict the authorities to manipulate the rules, which then is considered as acting with less freedom.

Where as rules will provide a certain limit within which the banks could necessarily make changes according to their decisions, which in turn as Friedman feels will improve the economic stability of the nation. References:Goodfriend, MV Monetary Policy Comes of Age: A 20th Century Odyssey. Economic Quarterly, Federal Reserve Bank of Richmond, Winter 1997, 1-22. Friedman, M. Essays in Positive Economics. Chicago: University of Chicago Press, 1953. Friedman, Milton. The Role of Monetary Policy.

American Economic Review, March 1968, 1-17. Friedman, Milton. The Case for a Monetary Rule. Newsweek, 7 February 1972.