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

Author(s): Bennett T McCallum , Edward Nelson

Publication Date: March 2001

Keyword(s): Rules , Discretion , Expectations , Policymaking

JEL(s): E30 , E52 , E58

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP2752.asp

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.