There’s been some recent controversy over the difference between rules and discretion in monetary policy, started, innocently enough, by a Don Boudreaux blog post and a Daniel Keuhn comment, then a full post by Daniel. Bob Murphy weighed in as well. I think part of the problem here is a dual meaning of the word “rule” in the context of rule-based monetary policy. The difference here is between a rule adopted by the central bank and one imposed on it.
One kind of rule is what we might call a policy-guiding rule (or what Buchanan might call a “post-constitutional rule”), such as the Taylor Rule. Yes, it’s a rule, but it’s a rule that informs the central bank of what sort of action it should take. So yes, the bank does not have full discretion if it is committed to that rule. However, the rule is one self-adopted by the central bank and, as Bob points out, if that’s subject to revocation in the face of a crisis, it’s really not too much of a rule.
Contrast that with a policy-constraining rule (or in Buchanan’s terms a “constitutional rule”). Imagine a constitutional provision, or even one imposed by the legislature, that said the money supply can only grow at 3% per year. Period. Such a rule would be much more constraining than a policy-guiding rule, and far less open to interpretation and not changeable by the central bank. It would also be, especially if constitutional, much harder to change, even in the face of a crisis.
It is the latter kind of rule that Friedman supported and it is the former kind of rule that commands the support Daniel refers to. They are not the same kind of “rule” despite both using the same word. The constitutional level rule is designed to tie the hands of the central bank and turn it into a conduit for a fixed growth rate. The policy-guiding rule tells central bankers what changes in the money supply they should be making, and it subject only to the whim of those in charge of policy at any given time. It is this last point that makes people sympathetic to Friedman unwilling to call that a “rule” in the same sense – it ultimately doesn’t constrain the central bank because it still has the discretion to change the rule.
Put differently, a policy-guiding rule is adopted by the central bank; a policy-constraining rule is imposed on the central bank. Their purposes are very different.
It is in this sense that Friedman opposed discretion and those in favor policy-guiding rules do not. Friedman’s rules are not changeable by the central bank itself; policy-guiding rules are. The central bank has discretion to pick its “rule.” That, Friedman thought, was the whole problem, hence his call for a rule to be imposed….