"Rules versus discretion": an essay on monetary policy in an inflationary environment

Introduction

Section I outlines the analytical foundations of two schools of thought which provide alternative frameworks within which it is possible to analyse the reasons for, and the limits to, the heavy reliance on monetary policy in combating inflation. This leads in Section II to the identification of three problem areas raised by the active, anti-inflationary use of monetary policy, each of these being discussed in a separate section. The questions looked at are: How to minimise the short-term social costs of such a policy - or, in other words, how to ensure its effectiveness (Section III)? How to deal with its longer-term potential costs (Section IV)? How to ensure the effectiveness of monetary control techniques (Section V). It will appear from the discussion that while the first two of these questions seem to be relevant to all industrial countries, the third is of major importance only to the "Anglo-Saxon" world, in particular the United States and the United Kingdom. Section VI examines some of the international implications of anti-inflationary monetary policies. The conclusions deal explicitly with the rules versus discretion issue.