another advantage of rules is the ease with which the public can determine its expectations. under a regime led by rules, at least some if not all elements that guide monetary policy are observable and thus agents can derive future monetary policy by means of the rule. but policy rules do have important drawbacks, which in the end are the reason why they are never used in practice as a guide for the conduct of monetary policy. john taylor himself notes it in his famous 1993 article that " [ … ] operating the rule requires judgement and cannot be done by the computer ". what he means is that policy rules have the disadvantage of being inflexible. since a rule must include some variables at the expense of others, it is obviously ill - prepared to unforeseen shocks that affect the economy. for example some demand shocks might require a quick response by the monetary authority in order to guarantee price stability. a solution to this problem consists in using a broader definition of a policy rule. taylor gives the example of patent laws. if an inventor obtains a patent, he has the right to exploit a certain principle for a couple of years. the details of the invention are not subject to the patent. in a similar way, a policy rule can be understood as a set of objectives and targets subject to which the monetary authority takes its decisions. in this sense, bounded discretion is a systematic collection of discretionary policy actions which, while leaving the flexibility to react to unforeseen events, offers the credibility and purposefulness of a rule. 1. 2 time inconsistency and policy there are hardly any scientific publications in economics that had as important an impact on day - today policy - making as the contribution of kydland and prescott. soon after identifying the inherent time inconsistency problem of optimal policy plans with rational expectations, similar problems were discovered in many areas of economic policy. the most important and influential ones were the time inconsistency problems concerning capital taxation in fiscal policy and the output inflation trade - off in monetary policy. although both problems reside in different domains of public policy the core of both remains the same. in addition to dealing with these, i will also review a peculiar kind of time inconsistency related to fiscal sustainability. 1. 2. 1 fiscal policy one important finding in the domain of public finance is the ramsey principle of optimal factor income taxation. developed in 1927 by the economist frank ramsey, it asserts that the input factor with the lowest elasticity

last 18 quarters consecutively. very similar results have also been extracted from other surveys like that of ‘ consensus economics ’ or the ‘ euro zone barometer ’. overall, the eurosystem has achieved credibility among market participants. this is also very important considering the uncertain environment, which the governing council of the ecb faces, in its day - to - day decision - making. in what follows, i am going to touch on this issue. monetary policy and uncertainty far from the deterministic world of models in which researchers can exactly predict the effects of a change in a certain variable, there is the real world, which the governing council of the ecb faces at its monthly meetings. there are many possible disturbances that feed the monetary framework with uncertainty in numerous respects. in the recent past, we had to deal with terrorist attacks, asset price bubbles and extraordinary rises in the oil price, just to mention a few. all of these events affect and change the structure of the framework a central bank has to deal with and add uncertainty to the process of conducting monetary policy. among the many forms of uncertainty the most relevant for central banks is twofold. the first concerns the transmission mechanism of monetary policy, the second is about the current state of the economy. concerning the mechanism of monetary policy transmission first of all, since the introduction of the euro we have noticed an important move towards a closer integration of capital markets and the banking system. this has impacting repercussions on the way and the amount by which interest rate decisions are passed through to the economies. nevertheless, since the euro area still remains heterogeneous in structure, the pass - through may be quick in one region while it is rather stodgy in another. recent labour market reforms in several member states as well as changes in social security systems influence the transmission mechanism further. all this continuously affects the process at hand and the euro area of today may well be quite different from that of 1999. the second important source of uncertainty concerns the state of the economy. again the division can be made between aggregate uncertainty and uncertainty at the country level. among experts the opinion is not always unanimous concerning the state of the economy. there are many indicators and many ways of interpreting them, so discriminating between a temporary slowdown of the economy and the beginning of a recession or between a sound recovery and irrational exuberance is not always obvious. it is no wonder that at times reference is made to the " art of central banking ".