Discretion rather than rules? When is discretionary policy-making better than the timeless perspective?
Discretionary monetary policy produces a dynamic loss in the New Keynesian model in the presence of cost-push shocks. The possibility to commit to a specific policy rule can increase welfare. A number of authors since Woodford (1999) have argued in favour of a timeless perspective rule as an optimal policy. The short-run costs associated with the timeless perspective are neglected in general, however. Rigid prices, relatively impatient households, a high preference of policy makers for output stabilisation and a deviation from the steady state all worsen the performance of the timeless perspective rule and can make it inferior to discretion. JEL Classification: E5
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