Tuesday, July 21, 2009

Discretionary Monetary policy and inflation

many economist find Friedmanُ s argument persuasive. Nevertheless, most believe that the fed conducts discretionary monetary policies. Indeed, economists at the fed-a few of whom even had Milton Friedman as a professor in years past- commonly defend fed discretion, arguing that fed has done much to reduce the durations of the various time lags. If the time lag problem is , or has been, solved , they contend, discretion is preferable to fixed policy rules.
In light of Friedman‘s model that we discussed above, this view has its merits. if the Fed could always learn quickly about the need for a policy action and respond quickly to that need, it might be able to conduct truly countercylical monetary policies.
It turn out, however, that there is another potential problem with discretionary policy making by the fed. As we explain below, monetary policy discretion may contribute to inflation. That is, a discretionary monetary policy maker may adopt inflationary policies that wanted result from a lack of a monetary policy rule. Furthermore, this could happen even if the fed does not want high inflation.Hence, rules still may be better than discretion.

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