Question

Explain the following:
Policy Rule
Discretionary Policy
Time Inconsistency
Rational Expectations
Policy Credibility

Answer 1

Policy rule is made by people who have goals and who must Calculate how best to achieve these goals given the environment they face.As long as the goals are constant in the environment.The policy makers should make decisions that have a pattern type.It should be easily understood by people who read them and the understanding of the environment.Policy rules are not exotic items in the macroeconomics. Discretionary policy is a policy which makes changes to the government spending or taxes.It is a demand side policy that uses government spending and taxation policy to influence the aggregate demand.It implies the government actions above and beyond existing fiscal policy and this often occurs in the times of economic turbulence or recession. Time inconsistency is when a decision maker preferences changes over time in such a way that the preference can be inconsistent at another point in time.It is also called as dynamic inconsistency.It is the difference between the value a person puts to anticipating something,the value the person put experiencing it and the value of the person places having experienced it. Rational Expectations is when a individual making a decision will base their decisions on best information available and learn from the past trends.It is the best to be considered for future making decisions.Rational Expectations assumes that people learn from their past mistakes.Rational Expectations have implications for economic policy.The impact will be different if people change their behaviour with the outcome that is needed or expected. Policy Credibility is where the central government clearly states its commitment towards its goals and in this it tries to achieve its price stability.Credibility is attained when the central banks actions are consistent in achieving its goals.