Credibility May Require Discretion, Not Rules

Abstract

We reexamine the common argument that rules produce greater credibility than discretion. Rules limit the actions of agents, restricting observations of the agents' preferences or types. In a second-best world, where rules cannot be everlasting, a regime of discretion in some periods may produce superior credibility and dominate a regime of rules.

Keyword(s): Rules, Discretion, Credibility, Regulation

JEL Classification: D78, D82, L51