“Rules Rather Than Discretion” After Twenty Five Years: What Have We Learned? What More Can We Learn?

Kydland and Prescott first identified the inflationary bias that results when a central bank does not precommit to a monetary policy rule. Subsequent work, published over the past twenty five years, demonstrates that this inflationary bias can be minimized by appointing central bankers whose preferences or incentives differ systematically from those of society as a whole. Subsequent work also shows that central bankers may optimally choose to maintain their reputations as inflation fighters. The literature to date, however, says remarkably little about how central bankers establish their reputations, or build credibility for their policies, in the first place.