The Role of Judgment and Discretion in the Conduct of Monetary Policy: Consequences of Changing Financial Markets

Conventional monetary policy rules based on intermediate targets, like the growth of money or credit, rest on the presumption that relationships correcting these variables to key measures of nonfinancial economic activity like income and prices are robust. When financial markets change in such a way as to disrupt those relationships, rules based on intermediate targets no longer provide useful guides for conducting monetary policy. Under those circumstances, the central bank can instead exploit variables like money and credit as information variables. Doing so, however, inevitably requires case-by-case judgments. The greater is the impact of changing financial markets in this context, the stronger is the need for the central bank to exploit information both inclusively, in the sense of drawing on multiple and diversified sources of information rather than any one variable, and intensively, in the sense of allowing less time between policy decisions.