Question

•What are the pros and cons of central banks setting policy based on rules as opposed to setting policy based upon the discretion of policymakers at each policy meeting?

Answer 1

Policies based on rules are tend to be more accurate and prone to less errors but it works only if the pre determined variables perform as they are expected to and this method suffers from the serious limitation of not able to adjust to sudden unexpected changes.

On the other hand, policies based on discretion are more adaptable and flexible to any sudden changes in expectations, but they get influenced due to inadvertent pressures and they are not always accurate and can lead to variations and deviations.

As a result, policies based on both rules and discretion are preferable in the long run.