Improving the use of discretion in monetary policy

This paper argues that the rules versus discretion debate has been miscast because a central bank does not have to choose only between adopting a policy rule versus pure discretion, both of which have serious shortcomings. Rather, it can choose a constrained discretionary regime that has rule‐like attributes. To make monetary policy discretion more rule‐like, it can be improved by (1) adopting a nominal anchor such as an inflation target, a monetary‐policy strategy that has proved to be very successful in recent years, and (2) communication of a monetary‐policy reaction process, especially through data‐based forward guidance, in which the monetary‐policy authorities describe how the future policy path will change as economic circumstances change.