Swings in the rules vs. discretion debate


This is John B. Taylor on the “Swings in the Rules-Discretion Balance“.  He distinguishes between an economic and a political rational in favor of rules.

This is the economic argument:

At their most basic level these policy rules are statements about how government policy actions will react in a predictable way to different circumstances. They can be stated algebraically as in many monetary policy rules such as the Taylor rule, which says that the short term interest rate should be set by the central bank to equal one-and-a-half times the inflation rate plus one-half times the GDP gap plus one.  But, of course, a rule does not have to be viewed as mechanical formula to be used rigidly. This brief review demonstrates that, from my perspective, the rationale for using rules over discretion in formulating macroeconomic policy is an economic one.

The word “balance” emphasizes that the ideal of a pure rule, without any discretion, is a theoretical abstraction. Evidence of the swing away from discretion is seen in actual fiscal policy and in the wide consensus among economists against the use of discretionary countercyclical fiscal policy in the 1980s and 1990s; it is also seen in the efforts to make monetary policy predictable and transparent, including through the use of inflation targets and actual policy rules for the instruments. The swing back toward discretion is found in the recent large discretionary fiscal stimulus packages and in deviations of monetary policy from the simple rules that described policy well in the 1980s and 1990s.

Next, Taylor cites Hayek in providing a political rationale in favor of rules:

Nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principles known as the Rule of Law. Stripped of all technicalities, this means that government in all its actions is bound by rules fixed and announced beforehand—rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances and to plan one’s individual affairs on the basis of this knowledge.

Though this ideal can never be achieved perfectly…the essential point, that the discretion left to the executive organs wielding coercive power should be reduced as much as possible, is clear enough.

If actions of the state are to be predictable, they must be determined by rules fixed independently of the concrete circumstances which can be neither foreseen nor taken into account beforehand.