The reigning paradigm in monetary theory and policy has settled on ‘constrained discretion’ as the preferred central bank operating framework. This supposedly combines the best features of rules and discretion in central banking.
But this romantic view is wrong. Constrained discretion is just discretion. No matter how smart or well-intentioned, discretionary central banking is plagued with information and incentive problems. These problems make it systematically unlikely that central bankers can deliver macroeconomic stability.
Furthermore, discretionary central banking implicitly violates many of the jurisprudential norms of liberal democracy. Especially since the 2007-8 financial crisis, discretionary central banking has demonstrated it is difficult to reconcile with self-governance.
We develop several novel arguments for why rules are preferable to discretion in monetary policy. Drawing on a wide body of scholarship, and especially the work of Nobel laureates Buchanan, Friedman, and Hayek, we show why discretionary central banking fails. We need rules, not discretion.