Question

Discuss 1. the moral hazard and 2. rules versus discretion as two potential dillemmas policymakers face within the context of managing the business cycle. Use examples to support each of your answers.

Answer 1

1) In Economics, when an entity's risk exposure increases as the risk isn't fully beared by the entity it is refered to as the moral hazards. For example an insured company takes higher risk because it knows that the associated cost will be payed by the insurance.

2)

Rules	Discretion
A policy can be made with respect to both, the rules and the dicretion. As both of them have their own advantages and disadvantages.
Rules provided consistency by making sure that the long run and short run outcomes are same to what is demanded by the public. Thus offering time consistency.	When the environment is uncertain, dicretion serves the people's requirements better by matching up the pronouncements of the policy makers.
It removes the possibility of uncertanity and states the exact same rule to be applied to minimize losses in the future.	It is situation based. A dicretion provides editing of policies according to the situation.
For example: The policy makers believe that a regulation set will provide the exact same benefit to the public in the long run as it does currently.	For example: Discretion is used by the local authorities to set the charges.

Both of these have their advantages and disadvantages as a rule set today might not be benficial in the future but it might also provide certainity. Whereas a dicretion may not provide certainity but will formulate itself according to the current situation. Such dillemmas policymakers face within the context of managing the business cycle.