In this session we want to understand: arguments for and against discretionary fiscal and monetary policies arguments fo

1. Rules Vs. Discretion In this session we want to understand: • arguments for and against discretionary fiscal and monetary policies • arguments for policy credibility

2. Rules Vs. Discretion Expected Perfect timing and information Real GDP Actual Policy tool Contractionary policy action

3. Rules Vs. Discretion • Problems with discretionary policies: • lags: • recognition lag

4. Rules Vs. Discretion • Problems with discretionary policies: • lags: • recognition lag • response lag • decision making

5. Rules Vs. Discretion • Problems with discretionary policies: • lags: • recognition lag • response lag • decision making • implementation process

6. Rules Vs. Discretion • Problems with discretionary policies: • lags: • recognition lag • response lag • decision making • implementation process • transmission lag

7. Rules Vs. Discretion Discretionary policies are destabilizing t1

8. Rules Vs. Discretion Discretionary policies are destabilizing Path of the target variable t1 Policy tool

9. Rules Vs. Discretion Discretionary policies are destabilizing. They increase their magnitude and longitude. t1 is the expected inflationary surge t1 t2 t3

10. Rules Vs. Discretion Discretionary policies are destabilizing. They increase their magnitude and longitude. t1 is the expected inflationary surge t2 is when the policy is implemented t1 t2 t3

11. Rules Vs. Discretion Discretionary policies are destabilizing. They increase their magnitude and longitude. t1 is the expected inflationary surge t1 t2 is when the policy is implemented t3 is when the policy becomes effective t2 t3 t4

12. Rules Vs. Discretion Discretionary policies are destabilizing. They increase their magnitude and longitude. t1 is the expected inflationary surge t1 t2 is when the policy becomes implemented t3 is when the policy becomes effective t2 The economy would have been out of its cyclical problem by t4 t3 t4

13. Arguements for • Policymakers have more information that households and firms • They act in the public interest rather for profit. This means they try to maximize the collective welfare.

14. Arguements against • Time lags • Policymakers act based on their own individual interest rather than public interest (Public Choice Theory)

15. Arguements against • The economy is usually producing below its potential because of : • income tax which discourages labor to supply less than they would otherwise do

16. Arguements against • The economy is usually producing below its potential because of : • income tax which discourages labor to supply less than they would otherwise do • government regulations discourage maximum production

17. Arguements against • The economy is usually producing below its potential because of : • income tax which discourages labor to supply less than they would otherwise do • government regulations discourage maximum production • Policy makers must choose between ultimate goals of achieving capacity output and inflation (PC). Policymakers are apt to enact policies that are inflationary (Robert Barro and David Gordon).