Rule versus Discretion

A line of demarcation between time-consistent and time-inconsistent policy must be maintained
"When a policy is framed, it can be either through rules or discretion." [Representational Image]
"When a policy is framed, it can be either through rules or discretion." [Representational Image] Pxfuel [Creative Commons]

When a policy is framed, it can be either through rules or discretion. The rules versus discretion framework are very useful for analysing a series of shocks and problems at macro level and COVID-19 is no exception.

Economists Finn Kydland and Edward Prescott were the first to offer a discourse on rule versus discretion debate in their masterpiece article of 1977.

They introduced a line of demarcation between time-consistent and time inconsistent policy. Under rules, there is time-consistency between the short-run outcome and long-run outcome demanded by the public.

Rules produce time-consistent results for the reason that they make pronouncements of policy-makers credible. Rules have great worth since we as public observe policy-makers and form expectations of their likely actions.

These expectations are rational. Public is rational in the sense that they have a correct understanding of the economy and therefore correctly anticipate the effects of the government’s economic policies using all available relevant information.

Under discretion, policy-makers can abandon or revoke current pronouncements tomorrow, and hence the public may label such pronouncements bad.

Under the policy of discretion, the public interests are better served when there is uncertainty but at the same time we believe the pronouncements of policy makers. In a rules framework, there must be a pre- specified plan as far as policy responses are concerned.

But, the plan can be activist or non-activist in nature. Under the activist plan, the rule may guide policy-makers to respond to different settings in different predetermined ways.

On the other hand, under non-activist plans, policy makers are forced to respond to different environments in the same ways. That is to say that, the rule may force the policy makers to undergo the same course of action under all situations.

Under monetary and fiscal policy, rule or discretion is essential to offset output fluctuations in an economy.

In the same way in COVID-19, rule or discretion is indispensable to counterbalance output and income fluctuations in general and health fluctuations in an economy in particular.

In monetary policy, discretion framework is very important since it offsets output fluctuations in Keynesian mechanisms.

On the other hand, monetarist school of economic thought offer a tight, fixed rule to satisfy basic objectives of monetary policy in general and ensure price stability in particular.

The overpopulated and underdeveloped economies are categorised by the bad rule versus discretion trade-off which is why the debate between the two is also ambiguous.

It has been argued in many theoretical and empirical research studies that underdeveloped economies are underdeveloped because there is a bad interface between fiscal and monetary policy and the two policies of development are in clash with each other.

In contemporary COVID-19 times which is a pandemic rule versus discretion nexus seems very difficult to understand. Since, rules are not as intense in underdeveloped economies as they are in developed parts of the world; these economies are caught under a vicious circle of poverty.

It is time to realise the fact that our health rules are very poor and our health stimulants are very weak and therefore we are badly caught in the COVID-19 web too.

Need of the hour in the situations like this pandemic is that people should understand the fundamentals between rules and discretion and accordingly resolve the debate between the two.

For that matter our economy requires a series of economists and policy experts who very well understand the nexus between rule and discretion.

Economists put great stress on the significance of not only suitable policy for a given set of circumstances but also the suitable framework that has a capacity to generate the best policy over a period of time.

Rational and wise policy-makers necessarily need to ponder through the public’s likely responses to their responses. It will produce consistently rigorous policy.

Dr. Binish Qadri,, Assistant Professor, Department of Economics, Cluster University, Srinagar.

Disclaimer: The views and opinions expressed in this article are the personal opinions of the author.

The facts, analysis, assumptions and perspective appearing in the article do not reflect the views of GK.

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