Revisiting the discretionary decision to introduce rules

A couple of days ago Scott Sumner had an interesting post on the theme “It’s policy regime that needs fixing”.

In his post Scott made an interesting observation:

“Good policy is rules-based, but first you must use discretion to decide the optimal rule. But we never actually do pick a rule, and hence the frustration of us rules proponents, we are always seeing the wrong debate take place.”

That reminded me about something I wrote back in May 2012. It is very similar to what Scott is saying. This is from my post “The discretionary decision to introduce rules”:

“At the core of Market Monetarists thinking is that monetary policy should be conducted within a clearly rule based framework. However, as Market Monetarists we are facing a dilemma. The rules or rather quasi-rules that are presently being followed by the major central banks in the world are in our view the wrong rules. We are advocating NGDP level targeting, while most of the major central banks in the world are instead inflation targeters.

So we have a problem. We believe strongly that monetary policy should be based on rules rather than on discretion. But to change the wrong rules (inflation targeting) to the right rules (NGDP targeting) you need to make a discretionary decision. There is no way around this, but it is not unproblematic.”

Scott’s as well as my point is that we need to get away from discussing the day-to-day policy actions of central banks. It for example does not make much sense to discuss whether the Federal Reserve should “taper” or not when it is unclear what monetary policy target the Fed is trying to hit.

Hence, we can really only understand whether monetary policy is too tight or too easy if we know what target the central bank is trying to achieve. Obviously we can assume that the Fed has a given nominal target and then argue that given that target it is right or wrong to taper presently.

Focusing on discussing monetary policy rules will also do a lot to unite Free Market economists who during the Great Recession have been split over the issue of how best to respond to the Great Recession. The point is exactly that central bankers should not be fire-fighters who makes discretionary decision to save the world from fires they often themselves have started. Optimally we should get rid of central bankers altogether and let rules and markets determine monetary conditions.

What we should be debating is what monetary policy rules best ensure nominal stability. I personally continue to think that NGDP level targeting is the “best” rule in terms of achieving nominal stability and the smallest level of distortion of relative prices, but there might be pragmatic reasons why other rules might be preferable for certain countries.

PS I am struggling a bit with a writer’s block at the moment. The key reason is that it so far has been an extremely busy year for me as there seems to be a constant flow of bad news for Emerging Markets. Lately of course the Ukrainian-Russian conflict has been taking a lot of my time and mental energy. I must admit that I am deeply worried about events in Eastern Europe and I find myself making historical comparisons that I don’t like to think about. Frustrations over bad central bankers is one thing – it is a completely another thing to worry about men with guns and bombs. Maybe in fact there is a relationship between the two things…anyway I would welcome any suggestions for topics regarding monetary issues that my readers would like to read about.

PPS If you want to understand what I worry about in relationship to the Ukraine-Russia situation you should read this book. Hopefully I am not overly hysterical in my thinking…

Leave a comment


  1. am

     /  March 15, 2014

    It may be a mistake asking for suggestions for topics to comment on. Wait for the deluge.

    A fragile state, inflation 9 per cent, single commodity dependent – copper, growth 5 per cent, donor dependent – nationally and government, declining currency – through commodity price decline and government budget deficit irresponsibility, corruption on large scale, increasing debt position, low level foreign reserves – 3 months, low productivity per capita.

    How does NDGP targeting work in such a situation especially in relation to making inflation reasonable, say no more than 3 per cent.

    Point being that inflation devalues what little the people have in their pocket to purchase basic items. Also assume inflation is increasing.

  2. Am,

    That sounds like Zambia! And I have actually been thinking about writing exactly about Zambia.

    Do think that the Zambian central bank should try to stabilize NGDP growth at a steady rate and it could do so by introducing a variation of what I have called the Export Price Norm. However, that would in the given state of declining copper prices lead to a fairly sharp depreciation of the kwacha and as a result most likely higher inflation. However, the alternative is a serious recession.

    As copper prices drop Zambia is certainly becoming a less wealthy country. There is little to do about that and more importantly the central bank’s task should not be to conduct monetary policy to ensure any form of income redistribution. That said, I am fully well aware that rising inflation is likely to hurt the poor more than the rich.

    However, monetary policy cannot do everything. Therefore, policy makers will have to introduce other policies to combat poverty. The best way to do that in my view is to ensure strong institutions – particularly the respect for the rule of law and protection of property rights. Furthermore, a redistributional scheme (A Citizen Account) like the one I have suggested for Venezuela might be an option. See here:

    I will take you up on the challenge and try to write a piece on these issues soon.

  3. Justin Irving

     /  March 15, 2014

    “It for example does not make much sense to discuss whether the Federal Reserve should “taper” or not when it is unclear what monetary policy target the Fed is trying to hit.”

    How is it that it is 2014 yet almost no one gets this simple idea!

    Seems to me that maybe 90% of macroeconomists (academics and business) treat the economy like its an…antique car whose mechanics are not well understood. Turn this crank 5 times and you might get it the motor going, but 6 times and the drive shaft might fall off. Thus we get these debates over everyone’s pet theory of the antique car, and how many times to crank the starter, when there is no car.

    I can’t think of a satisfying counter analogy, but the economy-as-machine model sucks. Its not a passive, Newtonian system, reacting to outside forces. It’s smart. It anticipates policy. It’s more like a tamed bear, or a horse that you want to get to cooperate than a car. If you have a monoploy on currency, just tell “the economy” about the nominal target, maybe prod it on a bit and Mr. Norris will handle the rest.

  4. It looks like in the absence of clear rules and guidance, people in the markets decide to create their own. For instance, here’s one strategist who says the Bank of New Zealand’s move to hike the rate will be keenly watched as a proxy for what happens to sterling

    I really think that central banks should do better when it comes to communication, and should stop moving the goalposts in the middle of the game – it helps nobody, not even themselves.

  5. Benjamin Cole

     /  March 18, 2014


    Events in Russia are disconcerting.

    But try to remember—it wasn’t that long ago that the Soviet Union was armed to the teeth, ICBMs, a KGB, blue water navy, millions of men in uniform, satellites, and was aggressively building tanks, submarines and ships.

    Back then, Ukraine was part of the SU and no bones about it.

    I can remember the 1962 Cuban Missile Crisis, and the very real idea we would get fried over an island in the Caribbean. JFK said it was 50-50 we blow. JFK’s military advisers told him to first-strike and nuke the SU hard and heavy….

    Those were the bad old days.

    But not so bad for monetary policy…lots of growth.

    So, try to place things in perspective. I expect Russia to collapse again, actually. It, and Ukraine, are too corrupt and have shrinking populations, and terrible alcoholism problems…brain drains…


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