Rules and discretion in public sector decision making are compared in a macroeconomic setting where there is a potential role for an active stabilization policy when the policymaker has private information about nominal shocks. The credibility of announcements about the state of nature is shown to depend critically on both the policymaker's preferences over output and inflation, and on the institutional setting (rules or discretion). Th e issue of rules versus discretion is found to depend on the flexibility lost under a rule relative to the time-inconsistency problem arising under discretion. Copyright 1988 by The editors of the Scandinavian Journal of Economics.
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