Rules, Discretion and Reputation in a Model of Monetary Policy

35 Pages Posted: 29 Jun 2004 Last revised: 15 Dec 2022

See all articles by Robert J. Barro

Robert J. Barro

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

David B. Gordon

Clemson University - John E. Walker Department of Economics

Date Written: February 1983

Abstract

In a discretionary regime the monetary authority can print more money and create more inflation than people expect. But, although these inflation surprises can have some benefits, they cannot arise systematically in equilibrium when people understand the policymaker's incentives and form their expectations accordingly. Because the policymaker has the power to create inflation shocks ex post, the equilibrium growth rates of money and prices turn out to be higher than otherwise. Therefore, enforced commitments (rules) for monetary behavior can improve matters. Given the repeated interaction between the policymaker and the private agents, it is possible that reputational forces can substitute for formal rules.Here, we develop an example of a reputational equilibrium where the out-comes turn out to be weighted averages of those from discretion and those from the ideal rule. In particular, the rates of inflation and monetary growth look more like those under discretion when the discount rate is high.

Suggested Citation

Barro, Robert J. and Gordon, David B., Rules, Discretion and Reputation in a Model of Monetary Policy (February 1983). NBER Working Paper No. w1079, Available at SSRN: https://ssrn.com/abstract=260532

Robert J. Barro (Contact Author)

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David B. Gordon

Clemson University - John E. Walker Department of Economics ( email )

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