Inflationary Finance under Discrepion and Rules

Inflationary finance involves first, the tax on cash balances from expected inflation, and second, a capital levy from unexpected inflation. From the standpoint of minimizing distortions, these capital levies are attractive, ex post, to the policymaker. In a full equilibrium two conditions hold: 1) the monetary authority optimizes subject to people's expectations mechanisms, and 2) people form expectations rationally, given their knowledge of the policymaker's objectives. The outcomes under discretionary policy are contrasted with those generated under rules. In a purely discretionary regime the monetary authority can make no meaningful commitments about the future behavior of money and prices. Under an enforced rule, it becomes possible to make some guarantees. Hence, the links between monetary actions and inflationary expectations can be internalized. There is a distinction between fully-contingent rules and rules of simple form. A simple rule allows the internalization of some connections between policy act ion and inflationary expectations, but discretion permits some desirable flexibility of monetary growth.