Question

Conducting monetary policy by the rule or by the discretion has pros and cons. What are pros and cons of conducting monetary policy via rules and discretions?

Answer 1

Monetary policy can have two general methods-using guidelines and flexibility. There is still hot debate among leading economists on the best approach. Nonetheless, central banks around the world continue to see more and more advantages in depending on rules: the FED, Bank of England, Bank of Canada are already implementing guidelines in monetary policy behaviour. According to the general theory of economics, a rule can be described as "nothing more than a systematic decision process that consistently and predictably uses the knowledge."

In contrast to the policy set by the predetermined rule, the discretionary policy is explained as an economic policy based on the ad hoc judgment of policymakers. Therefore, discretion makes no commitment to future policy actions Someone can be confused by the ambiguous distinction between inflation targeting and using a policy rule, which is very common among central bankers. It is important to stress that they are not identical. Inflation targeting by itself is more of a goal-setting approach; it does not define any methods for achieving the goal, nor does it prescribe any set of actions to execute.

All policies by law and by choice have their own pros and cons–the positives of one approach is the drawbacks of the other at the same time. The main advantage of policy rules is their clarity and continuity over time, whereas discretionary regulations are more versatile and can include a much wider collection of details. While it is clear how to quantitatively compare policies conducted by two different rules, it is not clear how to compare the policy by rule with a discretionary approach, since if we try to model discretion, it becomes automatically a rule