Rules versus Discretion: An Analysis of Income Stability and the Money Supply: Comment

Abstract

Through countercyclical monetary policies, the Federal Reserve attempts to promote economic growth and stability. Milton Friedman [4, 5] has argued, however, for the elimination of deliberate countercyclical monetary policies in favor of increasing the stock of money at a regular, steady rate. Friedman asserts that any conscious stabilization policy may contribute to instability because the outside lag in monetary policy is so long and variable. Bronfenbrenner [2, 3] and Modigliani [10] have performed some statistical tests of alternative monetary rules. The tests are designed to discover how well the money supply has been managed with discretionary authority. The performance of the monetary authority is then compared with what might have happened if the money supply had been managed according to some automatic rules. When the rules increasing the money supply at the constant rates of 3 percent or 4 percent per year are compared to the performance of discretionary policy, Modigliani's evidence supports discretionary policy over rules, provided the discretion is used in the pursuit of price stability and full employment [10, pp. 243-44]. However, when the 3 or 4 percent rules are made to compete with discretionary policy in Bronfenbrenner's test, the automatic rules are superior a 3 percent annual growth in the money supply being best [2, p. 13]. In a recent paper, the authors constructed and tested a model to determine whether the policies of the Federal Reserve have had a stabilizing or destabilizing effect on income during the post-accord period in the United States [9] . In the present paper, an attempt is made to evaluate the stabilizing