Moderated by Rich Danker in the Post Chapel with panelists:
- Zeno Dahinden
- David Garrett
- Dr. Michael Thomas who will provide a short introduction to the history of the debate over rule and discretion for the operation of central banks. Following high inflation and high unemployment in the US in the 1970s, monetary theory established that central bankers faced a "time inconsistency problem." This term, which was later to earn Ed Prescott and Finn Kydland the 2004 Nobel prize in economics, means that the temptation of central bankers to inflate to obscure the effects of a sour economy were too tempting to be avoided. The central banker would always maximize their choice between stimulating the economy and creating stable prices at a rate of inflation that was higher than it would be under rules.
Using either an adaptive or a rational expectations model the public would learn over time that this game was being played removing the positive impact of the choice a central banker had made. At the end of the story we would be left with high inflation (and the real costs associated with those distorted signals) but with no real advantage. To avoid this, firm rules would be preferred.
In the wake of this research many central banks around the world created rules or "targets" to ensure price stability since monetary policy discretion to stimulate weak economies could not be politically resisted. What is note worthy about this example is that it represents a remarkable empirical and theoretical convergence for the entire economics profession for the better part of three decades, only to be reversed with a renewed interest in Keynesian stimulus in more recent times.