Rules Rather than Discretion

Kydland, F. E., & Prescott, E. C. (1977). Rules Rather than Discretion: The Inconsistency of Optimal Plans. Journal of Political Economy, 85(3), 473-491.

Type

Journal article

Intellectual base

Primary research

Year

1977

Volume

85

Issue

3

Pages

473-491

DOI

10.1086/260580

DOI registrant

University of Chicago Press

Link

https://doi.org/10.1086/260580

Cited from

behavioral_economics, economics_finance, law_governance, philosophy

Cited by

8 citations across 8 artifacts.

Each citation links to the sentence it supports in the citing article.

Primes

• Autonomy
  • The structural argument for the arrangement is the time-inconsistency result: a discretionary government, re-optimizing each period, predictably produces an inflation bias, whereas a unit governed by its own pre-committed rule does not.
• Commitment Device
  • Kydland and Prescott (1977) gave this its canonical formal treatment, showing that a discretionary policymaker who can always re-optimize produces worse outcomes than one bound by a fixed rule, because economic actors anticipate the discretion and price in the expected reneging — the "time-inconsistency" problem that a credible commitment technology resolves.

    This sourceCanonical time-inconsistency result: a discretionary policymaker who can re-optimize produces worse outcomes than one bound by a fixed rule, because rational agents anticipate the reneging; supports the monetary-policy broad-use claim and the Kydland–Prescott example.

• Credible Commitment
  • Monetary policy and central banking. An independent central bank with a price-stability mandate is more credible at low-inflation promises than an elected government that can re-optimize opportunistically, and currency boards, inflation-targeting frameworks, and limits on debt monetization are commitment devices.

    This sourceIntroduces the time-inconsistency problem and the case for institutional commitment (rules) over discretion, the basis for central-bank credibility.

• Discretion
  • Their time-inconsistency result showed that retained discretion can be worse than commitment, because the ability to re-optimize each period undermines the credibility that makes policy effective.
• Editorial Independence
  • Central-bank independence is the cleanest analytic instance, because its rationale is a formal principal-agent argument about time-inconsistency that names every role of the prime.

    This sourceOriginates the time-inconsistency argument that motivates structurally committed (rather than discretionary) monetary policy.

• Temporal Inconsistency and Preference Reversals
  • The goal has not changed; the information available has not substantially changed; but the preference ordering inverts as the investment becomes imminent, the institutional analogue of the time-consistency problem Kydland and Prescott (1977) identified for optimal policy plans.

Mechanisms

• Constitutional or Policy Entrenchment
  • Any government that controls interest rates has a standing temptation to loosen policy before an election, so a bare promise of restraint is discounted in advance

    This sourceShows why discretionary anti-inflation promises lack credibility under rational expectations and can produce higher expected inflation.

• Delegated Enforcement Authority
  • Its strength is that it defeats time-inconsistency — the trap where the action you would rationally promise today is one you will rationally break tomorrow — by making tomorrow's choice belong to someone who won't be tempted.

    This sourceA time-inconsistent policy is one selected as optimal in advance that a later discretionary decision maker no longer finds optimal.

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