==> Steve Horwitz weighs in.
==> This was actually one of the few things I thought was cool in macro class in grad school. So let me reproduce the patronizing comment I left at Daniel Kuehn’s blog where he and I have taken the battle:
DK [Daniel Kuehn] wrote:
I suppose I was reading “do something that sucks” too narrowly. After all, presumably you don’t have to do what sucks if you have a rule you like! But that really depends on whether you like the rule or not!
Argh! You can interpret this as either really patronizing, or as kind-hearted. But, I am persisting with this because I’m still not sure you are getting my (modest) point. I keep thinking you and I are on the same page, but then you go and write a comment like this that makes me not so sure…
You can have a rule which simultaneously: (a) makes you worse off in certain situations, according to your own preferences, than you would be in the absence of the rule, and yet (b) makes you better off in the long-term. In other words, you sometimes benefit from having options removed, even if the removal of those options changes your behavior through time.
So suppose society “really” thinks that it is worth tolerating an extra 2 percentage points of inflation for every point of employment, relative to the baseline 2% inflation rate and 5% unemployment rate. Left to discretion, if the Fed found itself in an economy with 7% inflation and 7% unemployment, it would be willing to cut interest rates in order to move to 8% inflation and 6% unemployment, if it thought the Phillips Curve allowed such a tradeoff.
But, because people in the private sector know that the Fed will do this, it affects their long-term inflation expectations from time=1, and that itself influences what tradeoffs are possible, i.e. those very expectations influence the shape of the Phillips Curve.
So, you can come up with a model where if the Fed is forced to pretend that actually it should only tolerate a 1% point increase in excess inflation, if it will achieve a 5% reduction in excess unemployment, then the Phillips Curve is transformed such that, operating under this constraint, the resulting path of the economy is preferable to the one under discretion, even with the true social welfare function.
Then, once you get this result under your belt, you can then see why it makes sense to install a central banker who apparently really hates inflation. I.e. you install a central banker who hates inflation (compared to unemployment) more than “society” really does, so that when this stodgy banker sets discretionary policy, it actually is closer to the constrained rule policy.
Now maybe this type of model captures an important aspect of the real world, or maybe it’s nuts. But the comments I’ve been reading on your blog on these issues (not just from you, but from your commentators) makes it sound like this element is completely lacking. You guys seems to have just been talking about different ways of describing what the Fed could do, as opposed to seeing how (in principle) limits on the Fed could actually improve the outcome.
For further reading, or simply to substantiate my claims…ask Tyler Cowen. I have no idea what papers I read on this, I just remember thinking, “Ah, that’s pretty cool. For once the New Keynesian model with sticky prices and a representative household who lives forever, spits out something I like.”