Monetary Rules without Romance

Abstract

How much independence should the monetary authority retain in a rules-based regime? The conventional wisdom holds that while the political system - particularly in a democratic society - should determine the overarching goal of monetary policy, the central bank should remain free to select whichever "levers" it deems most appropriate for achieving the goal. This paper evaluates whether instrument independence is consistent with the goals of a rules-based regime by examining the monetary and macroeconomic effects of allowing the monetary authority discretion over the choice of control procedures when its objectives are at odds with the public interest. I argue that while a benevolent monetary authority would always select the most "efficient" policy instrument, i.e., the instrument consistent with achieving its stated objective, an opportunistic one may intentionally choose instruments that obscure its objectives, thereby undermining the purpose of monetary rules.