International Journal of Economics and Finance; Vol. 7, No. 4; 2015 ISSN 1916-971X E-ISSN 1916-9728 Published by Canadian Center of Science and Education 66 Rules vs. Discretion in Monetary Policy: From Commodity Money to Unconventional Monetary Policies Bogdan Badescu 1 1 The Bucharest University of Economic Studies, Bucharest, Romania Correspondence: Bogdan Badescu, The Bucharest University of Economic Studies, Unirii Boulevard, No.47, Block E3A, Floor 3, Ap. 6, Sector 3, 030825, Bucharest, Romania. Tel: 407-2365-6704. E-mail: bogdanbadescu82@yahoo.ro Received: February 5, 2015 Accepted: Feruary 11, 2015 Online Published: March 25, 2015 doi:10.5539/ijef.v7n4p66 URL: http://dx.doi.org/10.5539/ijef.v7n4p66 Abstract This paper proposes a review of the rules vs. discretion in monetary policy debate. Research shows that monetary regimes based on one or more rules had drawbacks, mainly due to the inflexibility imposed by these rules. Therefore, guiding monetary policy strictly by a set of rules is not the optimal approach. The late twentieth and early twenty-first centuries were characterized by a relaxation of the regulations in force, which led in 2008 to one of the worst economic crisis. Since the efficiency and correctness of the measures taken by the authorities as a response to the crisis are questionable and also that their long-term effects (especially the redistribution of wealth) and how to exit from them are still unknown, it becomes clear that a purely discretionary approach is not desirable either. Consequently, it should be implemented a more restrictive approach in terms of the discretionary component embedded in the authorities' decision. A starting point might be to increase the transparency regarding, for example, the algorithm by which the central banks set the policy rate or decide to increase the monetary base. In this sense, for central banks managing reserve currencies could be established publicly announced rules that govern the issuance of money and the policy rate. Moreover, such measures must be combined with improving the regulations in force, so that the attention will be also geared towards the microeconomic level, where it is most important to maintain financial stability. Last, but not least, it is important to remember that this stability should come as a result of the improvement of the general welfare, as the architects of the old Bretton Woods system envisioned. Keywords: monetary policy, rules, discretion, quantitative easing, inflation targeting 1. Introduction The crisis from 2008 and, in particular, the measures taken to remove its consequences reignited the discussion related to the necessity of rules governing the economic activity and, in particular, the money issuance. The idea of finding some rules to help to achieve some monetary targets is not new. According to some historians, the presence of this dilemma can be identified since the Roman Empire. Volkart (2007) examined the available data for 25 cities from the period 1352-1562 and concluded that those that managed their own currencies were more effective in ensuring their stability than cities whose currency was provided by a prince. In other words, the existence of rules aimed at maintaining the purchasing power of money is preferable to discretionary policies in this regard. Two centuries later, Smith (1776) noted in the “Wealth of Nations” that the use of paper money, provided their issuance is properly regulated, may “even bring benefits”. Ensuring the so-called proper regulation rose controversies. After some, the banks of issue had to adjust their activity as they saw fit, after others there had to be rules imposed. From the last category, the most prominent voice was that of Henry Thornton (1802), who argued that there is no automated method to control the amount of banknotes in circulation. Therefore, this task should be the responsibility of an institution (Bank of England) which was to guide the system based on some macroeconomic considerations. This view made Thornton to be considered the father of modern central banks. He sketched the principles that should guide such bank, among which was the recommendation that the amount of money in circulation should not be decreased but let to fluctuate within certain limits and allowed to increase slightly if the economic activity grew and also that the bank had to act temporarily off limits if there were extraordinary circumstances. After four decades occurred the famous debate between the currency and banking school. The firsts argued that inflation comes from excessive government