Real and Pseudo Monetary Rules

Milton Friedman is perhaps the best-known exponent of monetary rules. He also wrote a well-known paper entitled "Real and Pseudo Gold Standards" (Friedman 1961). I wish here to pay twofold homage to Friedman by insisting on a distinction between real and pseudo monetary rules. Just as Friedman (1961: 67) maintained that, though they may "have many surface features in common," real and pseudo gold standards "are at bottom fundamentally different," I shall argue that despite their superficial resemblance, real and pseudo monetary rules are fundamentally different--both in their operation and their consequences. Indeed, I shall argue that what Friedman called a "pseudo gold standard" is really an instance of a pseudo monetary rule, while what he calls a "real gold standard" is an instance of a real monetary rule. Real Monetary Rules A monetary rule, as typically defined, encompasses two very different sets of possibilities. For example, Froyen and Guender (2012: 101) define a monetary rule as "a prescribed guide for the conduct of monetary policy. " That broad definition includes both what I consider rules in the strict sense of the term--what I shall call "real monetary rules"--and rules in a much looser sense, which I consider to be "pseudo monetary rules. " To understand the difference between a real and a pseudo monetary rule, as well as my reason for insisting on these terms, one must briefly review the traditional arguments for monetary rules. The essence of these arguments is succinctly stated by Leitzel (2003: 50), who notes that while "discretion allows decisions to respond more closely to actual conditions . in the hands of a fallible or corrupt decision maker, a greater reliance on judgment may not be such a good idea. " Jacob Viner (1962: 246) gives a more detailed summary: On purely a priori grounds . it can be said for an unambiguous rule, provided it is enforceable and enforced, that it is a complete protection within the immediate area of its subject matter against arbitrary, malicious, stupid, clumsy, or other manipulation of that subject matter by an 'authority. ' It can be said for a ride rigid through time, if it works and is counted on to work, that it provides absolute certainy and predictability, with respect to the behavior prescribed by the rule [emphasis added]. A once popular and still occasionally heard objection to monetary rules is that discretion-wielding authority can almost always do better, since the authority can always reproduce the outcome of the rule yet can also respond to circumstances that the rule doesn't provide for. As Turnovsky (1977: 331) puts it, except when a rule happens to coincide with an optimal response, "a judiciously chosen discretionary policy will always be superior. " In other words, a discretionary policy need never do worse than a rule, and it might do better. Such arguments entirely miss the point. There are, first of all, several reasons why discretionary policy may in practice not be "judiciously chosen," in Turnovsky's sense of being an optimal response to the current state of the economy. The first, which O'Driscoll (2016) elaborates on in his contribution to this volume, is that the authorities may lack the knowledge required to employ discretion "judiciously. " The essential point was best expressed by Friedman (1960: 93): We seldom in fact know which way the economic wind is blowing until several months after the event, yet to be effective, we need to know which way the wind is going to be blowing when the measures we take now will be effective, itself a variable date that may be a half year or a year or two years from now. Leaning today against next year's wind is hardly an easy task in the present state of meteorology. Friedman is of course referring to "long and variable lags. " His argument hinges on the fact that monetary authorities, being incapable of anticipating such lags with any degree of precision, can be guilty of errors of commission more serious than the errors of omission to which a well-chosen rule might commit them. …