Classically Liberal Monetary Policy: Rules, not Discretion

Abstract

Classically liberal political economy highlights the importance of general, predictable, and nondiscriminatory rules for upholding the division of labor and maintaining social peace. Strangely, we exempt central banks from the discipline of rules, instead relying on bureaucratic discretion. This is a mistake. Discretionary central banking is economically ineffective: it cannot promote full employment and stable prices. Discretionary central banking is also illiberal: it suffers from a democratic deficit and undermines crucial norms of self-governance. The classically liberal alternative is rule-bound monetary policy. Unless we constrain central bankers with a strict rule, the promise of classical liberalism will not be fulfilled in the realm of monetary policy.

Keywords: central bank, classical liberal, democracy, monetary policy, monetary rule, nominal anchor, rules vs. discretion, self-governance

JEL Classification: E42, E52, E58, P16