Remarks by Governor Ben S. Bernanke
Before the Money Marketeers of New York University, New York, New York
February 3, 2003
"Constrained Discretion" and Monetary Policy
What is the appropriate framework for making monetary policy? This crucial question has sparked lively debate for decades. For much of the period since World War II, at least until recently, the debate has been carried on mainly between those favoring the use of rules for making monetary policy and those arguing for reliance on discretion.
Under a strict rules-based approach to monetary policy, advocated most prominently by Milton Friedman and his followers, the policy instruments of the central bank would be set according to some simple and publicly announced formula, with little or no scope for modification or discretionary action on the part of policymakers. For example, under Friedman's most famous proposal, the so-called k-percent rule (Friedman, 1960), the central bank would be charged with ensuring that some specified measure of the national money supply increase by a fixed percentage each year, irrespective of broader economic conditions. Friedman believed that such a rule would have the important advantage of preventing major monetary policy errors, as when the Federal Reserve permitted the U.S. money supply to collapse in the 1930s--a blunder that contributed substantially to the severity of the Great Depression. In addition, Friedman argued, a rule of this type would have the advantages of simplicity, predictability, and credibility, and it would help insulate monetary policy from outside political pressures and what Friedman saw as an inherent tendency toward excessive policy activism.
Neither the k-percent rule nor any comparably strict policy rule has ever been implemented, but "rule-like" monetary policy arrangements have existed in the real world. An important example is the international gold standard, the dominant monetary system of the late nineteenth and early twentieth centuries. Under the gold standard, at least in principle, the central bank's responsibility regarding monetary policy extended only so far as ensuring that the value of the currency in terms of gold was stabilized at the legally specified value. In short, under a strict gold standard the monetary policy rule would be, "Maintain the price of gold at so many dollars per ounce." Although the gold standard system malfunctioned and ultimately collapsed during the chaotic economic and financial conditions that followed World War I, many economic historians have credited it with promoting price stability and robust international trade and capital flows during 1870-1913, the so-called classical gold standard era.1 Another example of a rule-like monetary policy institution is a currency board, such as the ones currently employed by Hong Kong and several eastern European nations. ...........http://www.federalreserve.gov/BoardDocs/Speeches/2003/20030203/default.htm |
