The debate as to whether monetary policy is best conducted according to the discretion of the monetary authority (government or central bank) or according to a fixed set of preannounced rules. Proponents of a rules-based approach argue that anti-inflationary policy will lack credibility unless economic agents know that certain rules (e.g., regarding the setting of interest rates) will be applied mechanically, regardless of other pressures (see inflationary bias). Others argue that the monetary authority must retain flexibility in order to deal with unexpected shocks. The approach currently favoured by many Western govenments, in which the central bank is given independence but government sets firm inflation targets might be seen as a compromise between the two approaches.
Subjects: Financial Institutions and Services.