, a great deal. it is widely understood that governments can finance expenditures through taxation, debt – that is, future taxes – or printing money. in this sense, monetary policy and fiscal policy are intertwined through the government budget constraint. for good reasons, though, societies have converged toward arrangements that provide a fair degree of separation between the functions of central banks and those of their fiscal authorities. for example, in a world of fiat currency, central banks are generally assigned the responsibility for establishing and maintaining the value or purchasing power of the nation ’ s unit of account. yet, that task can be undermined, or completely subverted, if fiscal authorities set their budgets in a manner that ultimately requires the central bank to finance bis central bankers ’ speeches government expenditures with significant amounts of seigniorage in lieu of current or future tax revenue. 1 the ability of a central bank to maintain price stability can also be undermined when the central bank itself ventures into the realm of fiscal policy. history teaches us that unless governments are constrained institutionally or constitutionally, they often resort to the printing press to try to escape what appear to be intractable budget problems. and the budget problems faced by many governments today are, indeed, challenging. but history also teaches us that resorting to the printing press in lieu of making tough fiscal choices is a recipe for creating substantial inflation and, in some cases, hyperinflation. awareness of these long - term consequences of excessive money creation is the reason that over the past 60 years, country after country has moved to establish and maintain independent central banks – that is, central banks that have the ability to make monetary policy decisions free from short - run political interference. without the protections afforded by independence, the temptation of governments to exploit the printing press to avoid fiscal discipline is often just too great. thus, it is simply good governance and wise economic policy to maintain a healthy separation between those responsible for tax and spending policy and those responsible for money creation. it is equally important for central banks that have been granted independence to be constrained from using their own authority to engage in activities that more appropriately belong to the fiscal authorities or the private sector. in other words, with independence comes responsibility and accountability. central banks that breach their boundaries risk their legitimacy, credibility, and ultimately, their independence. given the benefits of central bank independence, that could prove costly to society in the long run. there are a number of approaches to placing limits on independent central banks so that the boundaries between

. of course, the fed has never adopted a formal reaction function or simple rule for setting monetary policy. but the fomc does look at the implications of various rules for interest rates when it makes its policy decisions. the fact that the fomc has not adopted a formal reaction function might reflect the desire for discretion on the part of some policymakers. but it also reflects the difficulty in reaching a consensus. the committee is composed of 19 members with varying views about how the economy functions, the shocks affecting the economy, and how policy should be set to meet the fomc ’ s monetary policy goals. despite not having formally adopted a particular rule, the john b. taylor, “ discretion versus policy rules in practice, ” carnegie - rochester series on public policy, north - holland, 39, 1993, pp. 195 – 214. bis central bankers ’ speeches fed appeared to behave in a systematic way at various times in the past. indeed, taylor ’ s 1993 article noted that his rule approximated federal reserve policy setting over the 1987 – 1992 period, save for a deviation during the stock market crash of 1987. i believe that despite the challenges, there would be large benefits to the fomc reaching a consensus on a reaction function that could serve as a useful guide to understanding its behavior. those benefits would be in the form of increased transparency and in the alignment of the public ’ s expectations with policymakers ’ intentions. as i ’ ve discussed before, there are limitations to the use of simple rules, and no central bank can be constrained by one simple rule in all circumstances. rules are basically intended to work well on average, but any central bank looks at many variables in determining policy. there will be times when policy must deviate from a reaction function or policy rule. however, simple rules do provide valuable benchmarks for assessing the appropriate stance of policy. they also provide guidance about the likely path of policy and thus are intended to reduce volatility. however, this outcome cannot happen unless the central bank is willing to publicly communicate a reaction function or rule. another benefit of articulating a rule is enhanced accountability. there will inevitably be times when economic developments fall outside the scope of our models and warrant unusual monetary policy action. events such as 9 / 11, the asian financial crisis, the collapse of lehman brothers, and the 1987 stock market crash may require departures from the simple rule. having articulated a rule guiding policymaking in normal times, the policymaker will be expected