DP2752 Timeless Perspective Vs Discretionary Monetary Policy in Forward-Looking Models

Author(s): Bennett T McCallum, Edward Nelson
Publication Date: March 2001
Keyword(s): Discretion, Expectations, Policymaking, Rules
JEL(s): E30, E52, E58
Programme Areas: International Macroeconomics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2752

This Paper reviews the distinction between the timeless perspective and discretionary modes of monetary policymaking, the former representing rule-based policy as recently formalized by Woodford (1999b). In models with forward-looking expectations there is typically a second inefficiency from discretionary policymaking, besides the inflationary bias. The Paper presents calculations of the quantitative magnitude of this second inefficiency, using calibrated models of two prominent types; it examines the distinction between instrument rules and targeting rules; and briefly investigates operationality issues involving the unobservability of current output and the possibility that an incorrect concept of the natural-rate level of output is used by the policymaker.