When individuals and firms have faith that monetary policymakers will stick to the rules over time, they can better anticipate the future and make economic decisions accordingly.Monetary policy

Richard W. Fisher

English

Research Papers in Economics

    President’sPerspective
When individuals and 
firms have faith that   
monetary policymakers 
will stick to the rules over 
time, they can better   
anticipate the future.
For centuries, economic sages have warned 
us in different ways that governments with 
the power to control their nations’ money 
would most certainly misuse it. To promote 
economic stability and prosperity, many have 
advocated delegating that power to a central 
bank that operates independently of political 
influences.
Among  these  illustrious  scholars  is  a 
humble and soft-spoken Norwegian named 
Finn Kydland, who shared the 2004 Nobel 
Prize  in  economics  with  his  colleague  Ed 
Prescott.  I  am  proud  to  say  that  Finn  has 
been  consulting  with  the  Dallas  Fed’s  Re-
search Department for 14 years.
Kydland  and  Prescott  demonstrated  the 
dangers of too much discretion in monetary 
policymaking.  They  identified  a  paradox  of 
“optimal” monetary policy: It will not always 
appear to be optimal. Future monetary poli-
cymakers  will  therefore  be  tempted  to  re-
place it with an alternative that seems better suited for the circumstances of 
the day. 
Capitalism thrives under a stable set of rules that everyone understands and 
obeys. Knowing this, Kydland and Prescott showed how unsettling a change 
in monetary policy rules can be. People will then expect the next set of rules 
to be replaced. And the next, and all the rules that follow. By changing these 
rules, monetary policymakers tarnish their reputations and lose their ability to 
credibly implement the best policies. They will be limited to suboptimal poli-
cies that lead to poor economic outcomes.
Kydland and Prescott argued that the best approach to monetary policy is 
strict adherence to a set of transparent rules from year to year and decade to de-
cade, even when alternative policies appear better. When individuals and firms 
have faith that monetary policymakers will stick to the rules over time, they can 
better anticipate the future and make economic decisions accordingly. 
Even with the best intentions, few political leaders would be able to resist 
the intense pressure to stray from the rules. Many central banks have failed to 
resist these pressures, too. Properly designed independent central banks are 
positioned to maintain discipline and follow the rulebook. Even in trying times, 
they will be calm and steady, untainted by the passion of the moment and im-
mune to political exigency and interference.
I invite you to learn more about Finn Kydland and his work in this issue’s 
“On the Record” interview.
 
  Richard W. Fisher
  President and CEO
  Federal Reserve Bank of Dallas

President's perspective

http://dallasfed.org/assets/documents/research/swe/2008/swe0803a.pdf

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