Monetary Policy in an Uncertain World: The Case for Rules

Moving to a rules‐​based regime would not eliminate radical uncertainty, but it could decrease institutional uncertainty—or what Robert Higgs (1997) has called “regime uncertainty”—and thus reduce the frequency of policy errors. Higgs focused on the uncertainty caused by fiscal and regulatory policies that attenuated private property rights by decreasing expected returns on capital. A discretionary monetary regime increases uncertainty about the future purchasing power of money and thereby undermines an important property right.

Radical uncertainty is a given, but institutional uncertainty can be reduced by adopting credible rules. As Karl Brunner (1980: 61) has pointed out,

Some congressional leaders think it’s time to create a rules‐​based monetary regime. The Financial CHOICE Act of 2017 (H.R 10), which recently passed the House, would make the Fed responsible for specifying a monetary rule and justifying to Congress any Fed deviations from it.¹

Whether the CHOICE Act passes or not, it is important to consider alternative monetary rules and to be prepared to make the case for rules over discretion when the opportunity for reform arises.

This article begins with a discussion of the case for rules over discretion in the conduct of monetary policy and draws upon the theory of monetary disequilibrium to support that case. In particular, a credible monetary rule can eliminate what Clark Warburton (1949) called “erratic money,” which he viewed as the chief cause of business fluctuations.

Various monetary rules will be examined, so will the difficulty of implementing them under the current environment in which unconventional Fed policy has plugged up the monetary transmission mechanism. Particular attention will be paid to rules designed to stabilize the path of nominal spending. The article ends with a call to establish a Centennial Monetary Commission to evaluate the Federal Reserve’s performance over its 100‐​plus years and to consider the ability of alternative rules to reduce regime uncertainty.

Notes:

¹ See Financial CHOICE Act of 2017 (H.R. 10): https://​finan​cialser​vices​.house​.gov/​u​p​l​o​a​d​e​d​f​i​l​e​s​/​h​r​_​1​0​_​t​h​e​_​f​i​n​a​n​c​ial_c….