In this session we want to understand:

1
Rules Vs. Discretion

• In this session we want to understand
• arguments for and against discretionary fiscal
  and monetary policies
• arguments for policy credibility

2
Rules Vs. Discretion

• Perfect timing and information

Expected
Real GDP
Actual
Policy tool
Contractionary policy action
3
Rules Vs. Discretion

• Problems with discretionary policies
• lags
• recognition lag

4
Rules Vs. Discretion

• Problems with discretionary policies
• lags
• recognition lag
• response lag
• decision making

5
Rules Vs. Discretion

• Problems with discretionary policies
• lags
• recognition lag
• response lag
• decision making
• implementation process

6
Rules Vs. Discretion

• Problems with discretionary policies
• lags
• recognition lag
• response lag
• decision making
• implementation process
• transmission lag

7
Rules Vs. Discretion

• Discretionary policies are destabilizing

t1
8
Rules Vs. Discretion

• Discretionary policies are destabilizing

Path of the target variable
t1
Policy tool
9
Rules Vs. Discretion

• Discretionary policies are destabilizing. They
  increase their magnitude and longitude.

t1 is the expected inflationary surge
t1
t2
t3
10
Rules Vs. Discretion

• Discretionary policies are destabilizing. They
  increase their magnitude and longitude.

t1 is the expected inflationary surge
t2 is when the policy is implemented
t1
t2
t3
11
Rules Vs. Discretion

• Discretionary policies are destabilizing. They
  increase their magnitude and longitude.

t1 is the expected inflationary surge
t1
t2 is when the policy is implemented
t3 is when the policy becomes effective
t2
t3
t4
12
Rules Vs. Discretion

• Discretionary policies are destabilizing. They
  increase their magnitude and longitude.

t1 is the expected inflationary surge
t1
t2 is when the policy becomes implemented
t3 is when the policy becomes effective
t2
The economy would have been out of its cyclical
problem by t4
t3
t4
13
Arguements for

• Policymakers have more information that
  households and firms
• They act in the public interest rather for
  profit. This means they try to maximize the
  collective welfare.

14
Arguements against

• Time lags
• Policymakers act based on their own individual
  interest rather than public interest (Public
  Choice Theory)

15
Arguements against

• The economy is usually producing below its
  potential because of
• income tax which discourages labor to supply less
  than they would otherwise do

16
Arguements against

• The economy is usually producing below its
  potential because of
• income tax which discourages labor to supply less
  than they would otherwise do
• government regulations discourage maximum
  production

17
Arguements against

• The economy is usually producing below its
  potential because of
• income tax which discourages labor to supply less
  than they would otherwise do
• government regulations discourage maximum
  production
• Policy makers must choose between ultimate goals
  of achieving capacity output and inflation (PC).
  Policymakers are apt to enact policies that are
  inflationary (Robert Barro and David Gordon).