Can the ‘constrained discretion’ model be used for fiscal policy?
Given that fiscal policy is also subject to pressures from the political process which result in expansionary biases, why not apply this ‘constrained discretion’ model to fiscal policy (this has been suggested by Blinder (1997))? The issue is whether a balance between ‘constraint’ and ‘discretion’ can be found which results in the optimal or near optimal setting of fiscal policy. With monetary policy, the long-term goal of policy is simple and unambiguous: the most that monetary policy can do is keep inflation under control, so the only issue is how much flexibility can be allowed for inflation to depart from the target in the short run (and how quickly to get it back on target if it is knocked off). So there is no ‘policy efficiency loss’ from the rule. But fiscal policy faces many more demands and the closest analogue to the inflation target is some sort of ‘golden rule’ budget constraint—that there should be a balanced budget over the long-term. This is going to be hard to evaluate
