Other Political Business Cycle Considerations
Chapters 6, 7, and 8 examined some of the theoretical and empirical characteristics of the electoral and partisan PBC effects. This chapter looks at some additional issues regarding political influence on macroeconomic policy and the economy. We will consider in more detail the main assumptions of the electoral and partisan effects. We will also discuss macroeconomic uncertainty and its influence on election outcomes. Finally, we will examine the subject of central bank independence and the related topic of a monetary policy rule.
Main Assumptions of the Electoral and Partisan Effects
Three key assumptions underlie the electoral and partisan cycle effects:
- •President’s Policy Preference: The partisan and electoral effects assume that the president’s macroeconomic preference focuses on partisan goals or reelection ambition.
- •Presidential Power: The partisan and electoral effects assume that the president has power to determine macroeconomic policy.
- •Macroeconomic Predictability: The partisan and electoral effects assume that the impact of stabilization policy on the economy is accurate and predictable.
Let us consider each of these assumptions.
The president’s policy preference focuses either on partisan economic goals or on increasing reelection votes according to the electoral and partisan effects. For example, if the median voter’s macroeconomic preference is dynamically inconsistent, then the president might support an opportunistic policy as an attempt to gain reelection.
The president, on the other hand, could prefer a different economic strategy, even if opportunistic policies would be effective in increasing reelection votes. Various factors can impact a president’s policy preference. Ethical considerations, for example, may cause an incumbent to reject opportunistic policies. The electoral cycle effect is Machiavellian in nature. The ends justify the means. To increase reelection votes, citizens are misled into accepting fleeting economic gains that occur at the expense of higher postelection inflation, which may be followed by a disinflationary recession.
Other concerns could also cause an incumbent not to pursue PBC policies. The president may have a different macroeconomic agenda besides partisan priority or reelection ambition. An administration might choose to concentrate on issues such as reducing government debt, tax reform, health care, poverty alleviation, international trade, education, national defense, or environmentalism. The president, however, must be able to resist PBC political pressures to pursue a distinct macroeconomic program. Many motivations likely affect the economic agenda of a presidential administration, such as political party platform, reelection strategies, and fulfillment of campaign promises.
President’s Influence on Macroeconomic Policy
The next issue is the president’s power to influence the macroeconomic policy. The incumbent does not fully determine the macroeconomic policy. The president does not completely decide the fiscal policy and has only an indirect influence on the monetary policy. The president is therefore not always able to attain the desired macroeconomic agenda.
Monetary policy is directly determined by the Federal Reserve and not by the executive branch. To reduce undue political influence, the Fed has been set up as an independent institution. The Fed is not required to adhere to the economic preferences of the president or the Congress. The incumbent, however, may indirectly affect the Fed through the presidential appointment of the Fed Chairperson. The Fed Chair, for instance, may choose to support the incumbent’s macroeconomic agenda because of loyalty to the president or out of ambition to be reappointed as Fed Chair.
Additionally, fiscal policy is not under full control of the presidency. Fiscal policy is determined by the political compromise between the president and the Congress. Fiscal policy occurs mainly through the federal budget process. The fiscal policy process also involves the partisan economic platforms of the right and left political parties and their influence on the president and the Congress.
The president’s impact on fiscal policy is likely to be substantial in a unified government. A unified government occurs if one political party controls both the executive and legislative branches. This takes place if the in-party to the White House possesses a majority of seats in both the Senate and House. The number of in-party legislators is greater than the number of out-party legislators in a unified government. The in-party legislators can outvote the out-party legislators. In-party legislators in the House and Senate are likely to support the president’s budget proposal and other fiscal policy initiatives by the administration. The president has a relatively strong sway over the level and distribution of taxes and government expenditures in a unified government.
A presidential administration is more likely to achieve its fiscal policy agenda in a unified government than a divided government. A divided government occurs if one party controls the presidency while the opposing party has a majority of the seats in Congress. A divided government also occurs if one party has a majority of seats in the House of Representatives, while the opposing party has a majority of seats in the Senate.
Partisan gridlock may occur regarding fiscal policy in a divided government. The out-party in control of Congress may oppose the fiscal policy program of the in-party in control of the Oval Office. The out-party legislators outnumber the in-party legislators in a divided government. The out-party legislators are likely to oppose the president’s budget proposal. The in-party legislators are likely to support the president’s budget plan. The out-party legislators, however, can outvote the in-party legislators. The president consequently has weaker sway over fiscal policy in a divided government than a unified government. If partisan gridlock occurs, neither political party is likely to achieve their preferred fiscal policy. Both parties must compromise on taxes and government spending. This process of finding compromise on taxes and government spending may be difficult because the political left and political right often clash on the role and size of government in the economy. In a worst-case scenario, a government shutdown could occur until compromise is reached.
Another partisan-related effect is that the out-party may choose to oppose fiscal policy initiatives by the president that could boost the economy and improve reelection chances for the in-party. A strong economy leads to an increase in presidential and congressional votes for the in-party and a decrease in votes for out-party candidates. Consequently, the out-party may cynically hope for a weak economy prior to a presidential election or a midterm election. A slow economy in an election year tends to boost presidential and congressional votes for out-party candidates and reduce votes for in-party candidates.
Macroeconomic Unpredictability and the Policy Lag Effect
A further matter is the partial unpredictability of the economy in reaction to policy. RGDP, unemployment, and inflation do not always respond to macroeconomic policy in terms of magnitude or timing as intended. Suppose the president manipulates policy for an intended electoral cycle effect. Opportunistic policy does not guarantee the economy will react precisely as predicted. The macroeconomy does not always respond in the time frame nor to the extent that is planned.
An attempt by the incumbent to orchestrate an electoral effect (or a partisan effect) could be thwarted by uncertainty and unpredictability on the impact of policy on the economy. Fine-tuning of the economy through policy to create a PBC effect may be difficult to achieve. The macroeconomic policy could mistakenly overshoot or undershoot a desired electoral cycle effect. If opportunistic policy is too weak, the economy will not expand sufficiently prior to the election as planned by the incumbent. The administration, consequently, will not achieve its goal of a strong pre-election economic stimulus. The in-party could consequently lose reelection to the White House because of weaker than anticipated economic performance. Alternatively, if opportunistic policy is too strong, then inflationary overheating develops prior to the presidential vote, which hurts reelection chances.
Besides uncertainty on the effects of macroeconomic policy, the second issue regarding unpredictability is policy timing. A time lag occurs between the implementation of policy and its subsequent influence on the economy. Because of policy lag uncertainty, policy could be inaccurately timed. Policy may impact the economy too quickly or too slowly. If the impact of an electoral-cycle policy occurs too rapidly, rising inflation develops prior to the election rather than afterward as intended. This unintended preelection inflation jeopardizes reelection ambitions for the in-party.
Alternatively, opportunistic policy may impact the economy more slowly than predicted. The economic boom consequently occurs after the election rather than before. The in-party could lose reelection because of the lagged response of the economy to expansionary measures. The economy during the G.H. Bush presidency may have been an instance of the policy lag effect in connection with the 1992 presidential election. The economy throughout the G.H. Bush presidency of 1989 to 1992 exhibited a conservative partisan cycle pattern of disinflation and rising unemployment. This partisan macroeconomic effect was in contrast to the electoral cycle pattern that seemed to occur for most other Republican terms during the post-1960 time frame (see Chapter 8 for a discussion).
Monetary policy during the G.H. Bush term, however, became expansionary prior to the 1992 presidential vote, perhaps as an attempt to create a preelection economic expansion. Monetary policy turned expansionary toward the end of the G.H. Bush term as predicted by the electoral cycle. M1 money supply growth was low at a disinflationary rate of 3.6 percent during 1989 to 1990. Money supply growth then increased to 6 percent in 1991, and to an expansionary rate of 12.4 percent in the election year of 1992 (Federal Reserve Economic Data). This shift from a disinflationary policy to an expansionary policy toward the end of the G.H. Bush term, however, did not yield lower unemployment until after the 1992 presidential election, rather than prior to the vote as expected by the electoral cycle. Unemployment remained high at 7.8 percent in 1992. In 1993, however, after the election, unemployment fell to as low as 6.5 percent (Bureau of Labor Statistics).
The expansionary monetary policy, in other words, may have had a slower than expected impact on the economy toward the end of the G.H. Bush term. The economy may have exhibited a failed electoral cycle during the G.H. Bush presidency. The weak economy in the election year of 1992 was a major cause for the reelection defeat of G.H. Bush. If unemployment had declined prior to the 1992 vote rather than afterward, G.H. Bush would probably have received a higher presidential reelection vote share.
Macroeconomic Shocks and Macroeconomic Uncertainty
Exogenous shocks are major external events that alter economic performance from its previous pattern. Shocks are an inevitable and periodic characteristic of the economy and a source of uncertainty. Exogenous shocks can either cancel out or amplify macroeconomic policies, including actions based on reelection ambition or partisan priorities. Economic shocks may also be beneficial or detrimental. A beneficial shock improves the economy and likely boosts presidential approval and the presidential reelection vote share. An adverse shock worsens the economy. This weakens presidential approval and reduces the presidential reelection vote share for the in-party.
Exogenous shocks may occur on the supply side as well as the demand side of the economy. Two types of supply-side shocks are commercial technology and resource costs, especially energy prices. For example, a dramatic and sustained change in oil prices could either exacerbate or negate a PBC effect. A substantial decline in oil prices prior to a presidential election could cause both inflation and unemployment to fall as well as economic growth to expand. This magnifies an electoral cycle effect. The political result of this positive supply-side shock is likely to be an increase in presidential approval and an increase presidential reelection votes.
An instance of this type of supply-side effect was the decline in oil prices during the early 1980s. This positive supply-side effect strengthened the economy toward the end of Reagan’s first term in the White House. Both inflation and unemployment fell. This was a positive factor in Reagan’s reelection victory in 1984. A similar supply-side effect was the decline in oil prices prior to the 2004 presidential vote. This led to disinflation in the election year. This may have been a contributing factor in G.W. Bush’s reelection victory.
Conversely, a substantial rise in oil prices can cause both inflation and unemployment to worsen. If this happens prior to a presidential election, then the reelection votes for the in-party presidential candidate will probably decline. An example of this effect was the energy shock on the 1980 presidential election. The Oil Crisis of 1979 to 1980 occurred toward the end of the Carter term. This shock caused the economy to diverge from its previous liberal partisan cycle pattern of declining unemployment (see Chapter 8). Instead, stagflation occurred because of the oil crisis. Both unemployment and inflation rose prior to the 1980 vote. This was a major factor in the presidential reelection defeat of Jimmy Carter.
Besides supply-side shocks, macroeconomic shocks can occur on the demand side. An important demand-side factor is the periodic occurrence of large private debt bubbles. An example of a debt bubble crisis was the real-estate and financial crash that lead to the Great Recession prior to the 2008 presidential election. The Great Recession began in the final year of the G.W. Bush presidency. In 2006 and 2007 prior to the financial crisis and the Great Recession, a pattern of slight disinflation arose. This economic effect is consistent with either the electoral cycle or a conservative partisan cycle (see Chapter 8 for a discussion). This macroeconomic pattern, however, was interrupted in 2008 by the shock of the financial crisis and the Great Recession. Consequently, both inflation and unemployment increased. This stagflationary outcome was a key factor in the Republican loss of the White House in the 2008 presidential election.
Macroeconomic Uncertainty and Presidential Reelection Vulnerability
Economic events obviously fluctuate across presidencies. This happens partly because of the complex relationship and interaction among the macroeconomic policymakers and the various considerations that weigh on policy decisions. The policymakers are the president, the Congress, the Fed, and the indirect influence of the liberal and conservative political parties. These policymakers interact with one another to influence fiscal and monetary policies.
The process of macroeconomic policy and its effect on the business cycle do not follow one simple pattern over time across all administrations. In Chapter 8, we examine business cycle data and found evidence for differing PBC effects across Republican versus Democratic presidencies. Different policymakers have different macroeconomic priorities at different times. Policymakers also face differing economic circumstances at different times, such as periodic episodes of recession versus other periods of high inflation. These fluctuating economic circumstances lead to different macroeconomic policies across different incumbencies. Additionally, stabilization policy lag, exogenous economic shocks, and various macroeconomic uncertainties and rigidities create unpredictability in the business cycle.
The reelection prospects of a president are vulnerable to economic uncertainty. An incumbent’s chance of reelection is partly dependent on the fortune or misfortune of a partially unpredictable economy. The president may adopt policies based on reelection ambition, partisan priorities, or other objectives. The fickleness of the economy, however, partially jeopardizes the realization of these goals.
The unpredictability of the ups and downs of the business cycle can impact whether the economy is strong or weak on election eve. The good luck or bad luck of the business cycle influences presidential and congressional election outcomes. The fortune or misfortune of the economy in an election year affects which candidate and political party win and who lose in presidential and congressional elections.
The incumbent is held accountable to voters in elections based on how well the economy performs. This accountability occurs regardless of whether the president is responsible for the economic events. The incumbent is rewarded with a high reelection vote share if a strong economy occurs. This electoral outcome tends to take place irrespective of whether the administration creates the favorable macroeconomic outcomes or not. An incumbent might be reelected because of a strong economy that is unrelated to the president’s policies. A president tends to receive a low reelection vote share if a weak economy occurs. This tends to take place regardless of whether the administration’s policies cause the poor economic performance or not. An incumbent might lose reelection because of a weak economy that is beyond the control of the administration to prevent.
Central Bank Independence?
The Federal Reserve System is an independent government entity. The institution is set up to be insulated from excessive special interest influence and undue political and partisan pressures from the president and the Congress. The independent nature of the central bank is based on the concept that monetary policy should be protected from political pressures that could be unstable and inefficient. The monetary policy decision-making process is designed to be autonomous and based on economic criteria rather than shifting political winds. In the absence of an independent Fed, Congressional and presidential politics could influence the central bank to adopt monetary measures based on popularity, special interests, partisanship, or political expediency rather than economic considerations.
Macroeconomic circumstances, for example, may sometimes require unpopular actions by the monetary authority. A tight monetary policy, for example, is often necessary to resolve high inflation. Disinflation from tight policy can cause a temporary recession because of the short-run inflation–unemployment trade-off. While effective at reducing inflation, restrictive monetary measures can be controversial among voters and interest groups because of the negative side effect of an economic slowdown. Opposition to central bank policy can consequently develop. This political discontentment could influence monetary policy decisions in the absence of an independent Fed. The central bank might be politically pressed to adopt an expansionary policy to alleviate the economic slowdown, but with the long-term consequence of an even further rise in inflation.
Three Elements of Central Bank Independence
The independent nature of the Fed includes three elements:
- 1.The Fed earns its income rather than being dependent on the Congress for funding.
- 2.The Fed chair and Board of Governors are appointed to serve terms that extend across multiple presidencies.
- 3.Monetary policy does not require approval from the Congress or the president.
The Fed is financially insulated from partisan and electoral pressures of the executive and legislative branches. The Fed earns its own income rather than being reliant on the Congress for funding through the federal budget. The central bank is not subject to the budgetary process of political interaction among the Congress, the presidency, and the political parties. The Fed does not depend on taxes to finance its operations and activities. Instead, the Fed earns income through bank fees, interest payments, and other charges for various services it provides to member banks of the Federal Reserve System. The central bank thus maintains financial freedom from the presidency and the Congress. If the Congress could determine the central bank’s budget, then the Fed might be pressured to acquiesce to Congressional preferences on monetary policy and banking regulations.
Besides financial independence, a second aspect of central bank independence is the appointment of Fed officials. The president appoints the seven members of the board of governors of the Fed. Each member serves a nonrenewable, staggered 14-year term that spans across multiple presidential administrations. One new board member is appointed every 2 years to replace a retiring member. This creates the staggered effect.
The president also appoints the chair and vice-chair of the board of governors. These appointments consist of renewable 4-year terms. The chair, vice-chair, and other members of the Board of Governors, combined with 5 of the 12 Federal Reserve District Bank Presidents, constitute the Federal Open Market Committee (FOMC). The FOMC determines monetary policy and its influence on money supply and interest rates. The appointed Fed chairperson is particularly important in the monetary policy process. The Fed chair sets the monetary policy agenda for the FOMC.
Because of the appointment mechanism of Fed officials, the actions of the central bank are not directly subject to democratic elections. Electoral determination of Fed officials could conceivably compromise the economic integrity of monetary policy. If central bank policymakers were accountable through periodic elections, then the central bank might decide to adopt policies based on popularity or political expediency rather than economic criteria that may sometimes be unpopular but necessary (such as a tight policy to alleviate high inflation that could cause an unpopular temporary recession).
The third main element of central bank independence is that monetary policy does not involve approval from the president or the Congress. Elected politicians, however, have a strong interest in Fed actions because of its impact on the economy. The state of the economy affects voter well-being and therefore election outcomes. Consequently, elected officials often express their viewpoints about the Fed and monetary policy. However, neither the executive nor legislative branches can mandate the direction of monetary policy because of the independence of the central bank.
Fed Independence Is Partial
The monetary authority is not completely immune from political pressures associated with special interests, voters, the Congress, and the presidency. One interest group that may influence central bank policy is the financial industry. One criticism of the Fed is that banking and financial interests have excessive impact on central bank decisions. The Fed might adopt policies that benefit financial institutions more than the overall economy. Additionally, many members of the Board of Governors of the Fed have career connections to banking and financial institutions. These interconnections can create a conflict of interest.
The central bank could be pressured to adopt monetary and regulatory policies that increase the profitability of Wall Street to the detriment of the total economy. In a worst-case scenario, a boom-and-bust economic cycle could arise that benefits financial markets and financial institutions. The Fed, for example, might adopt excessively expansive monetary measures and lax banking regulations that boost the short-term profitability of financial firms in the form of a booming stock market and high returns on risky financial loans and bonds. Weak financial regulations could enable excessive unsafe loans combined with rapid money supply growth that keeps interest rates too low for too long.
This type of scenario may have played out with the financial crisis of 2007 to 2008 and the corresponding Great Recession of 2007 to 2009. Prior to this crisis, a financial bubble arose in the form of high private debt from risky mortgage loans combined with low interest rates and stock market speculation. This bubble eventually burst through risky loan defaults and a stock market crash. The economy subsequently sunk into a severe recession. In the end, big banks and financial institutions were bailed out by the government.
Besides the influence of the financial industry, the Fed is partially subject to presidential and Congressional pressures. The Fed chair, for example, must testify before the Congress on a periodic basis regarding monetary policy and the state of the economy. The Fed chair is not compelled to adhere to the recommendations of legislators in Congressional hearings. The central bank, however, may experience political pressure to alter policy to accommodate Congressional sentiment. Congress, for instance, could threaten to pass laws that interfere with monetary policy. In an extreme circumstance, the Congress could threaten impeachment of the Fed chair if legislators considered central bank policies to be irresponsible.
Congressional influence on the central bank could be either beneficial or harmful. If Congressional pressure on the Fed is based on shifting and inefficient politics and partisanship, then Congressional involvement with the monetary authority can become detrimental. If, however, Congressional monitoring of central bank activity is based on reasonable analysis, then legislative oversight of the Fed is beneficial safeguard. Besides Congressional pressure on the central bank, the greatest source of executive branch influence is the presidential appointment of the chair of the central bank. The president is likely to appoint a Fed chair who embraces the same macroeconomic agenda as the administration. Out of loyalty, the Fed chair may also feel pressure to adopt a monetary policy consistent with the economic preferences of the president.
Executive branch influence on the central bank could be further exacerbated if the Fed chair seeks reappointment. In hopes of reappointment to the position, the Fed chair may enact monetary policies in line with the administration’s economic program. On the other hand, the Fed chair and the FOMC might choose to adopt monetary policy that conflicts with the administration’s priorities. In this case, the president may decide not to reappoint the Fed chair and instead assign a different member of the Board of Governors to the position. Based on these executive branch pressures on the central bank, the electoral and partisan PBC effects assume that monetary policy tends to follow the president’s preference.
Besides financial interests and presidential and Congressional pressures, the Fed is scrutinized by the media, various other special interests, opinion leaders, political parties, and the public. Any individual or group may criticize the central bank if monetary policy is perceived as too expansionary or too contractionary, or if banking regulations are considered too weak or too restrictive. Likewise, any group or person may praise the Fed’s actions if monetary policy and financial regulations are viewed as effective. Various political influences likely exert some impact on the central bank. The magnitude of these external political pressures on monetary policy is difficult to calculate.
The net impact of outside political forces on central bank policy could be either beneficial or detrimental based on the farsightedness or shortsightedness of the various pressures. If the impact of politics on the Fed is shortsighted, then monetary policy could become too contractionary or too expansionary. External political influence on the Fed could also be beneficial. From the Congressional and presidential perspectives, the central bank should consider their sentiments, which reflect the attitudes of voters, political parties, and interest groups. If the macroeconomic perceptions of the Congress and the administration are enlightened and farsighted, then their pressure on monetary policy is helpful. Enlightened political pressures could influence the monetary authority to have a more responsive policy.
The independent nature of the Fed could have either a positive or negative overall effect. Central bank independence is effective if the Fed adopts efficient monetary policy based on economic criteria as intended. Central bank independence, however, could conceivably become detrimental. An independent Fed is potentially harmful if the central bank is not held accountable for mismanagement of monetary policy decisions should they occur. Central bank independence could lead to policy actions that are out of touch with societal economic needs. The central bank might pursue short-term financial interests to the detriment of the overall economy. Excessive banking deregulations or overly expansive monetary policies could lead to financial bubbles that bulge and then burst.
Discretionary Monetary Policy versus a Monetary Policy Rule
Macroeconomic policy occurs according to the discretionary judgment of the policymakers. The discretionary interaction between the president and the Congress determines fiscal policy. The discretionary interaction between the Fed chair and the other FOMC members determines monetary policy. Additionally, political pressure from voters, political parties, the media, and interest groups likely has some indirect influence on the discretionary actions of the fiscal and monetary policymakers.
For example, the president as well as Congressional legislators may have difficulty gaining reelection if their policies do not reflect citizen sentiment on the economy. Additionally, elected officials may have difficulty obtaining sufficient financial backing for election campaigns if their policy platforms do not consider the macroeconomic preferences of their political party as well as interest groups such as business, finance, and labor.
For monetary policy, the Fed chair may have difficulty gaining reappointment from the president if monetary policy does not take into consideration the macroeconomic preferences of the administration, voters, political parties, interest groups, and the media. One issue is that political pressure from voters and other outside influences on discretionary policy could be naïve, shortsighted, or biased. Policymakers might be swayed to adopt unsustainable policies that act against the long-term macroeconomic interests of society.
A monetary policy rule, although controversial, is one proposal for addressing the potential problem of shortsighted political influence on discretionary monetary policy. According to this concept, a mathematical rule is created to govern money supply. This fixed rule is mathematically based on macroeconomic criteria. This contrasts with the present process of discretionary judgment by the FOMC. One possible policy rule is that money supply growth equals a constant rate plus some parameter times the unemployment gap:
Money growth = constant + b (actual unemployment rate
− natural unemployment rate)
Money supply growth is equal to a constant level (of say 3 percent) if the economy is at full employment. An efficient economy occurs if actual unemployment equals the natural rate. If the economy is weak at an unemployment level greater than the natural rate, then money supply growth automatically increases based on the parameter b in the policy rule. This higher money growth leads to lower interest rates, higher macroeconomic demand, and less unemployment. If the economy is overheated at unemployment that is less than the natural rate, then money supply growth automatically decreases based on the policy rule. Consequently, interest rates rise and macroeconomic demand declines to reduce inflationary pressures.
A criticism against the concept of a monetary policy rule is that the method is too rigid in an environment of macroeconomic uncertainty. The economy might be adversely impacted by a rigid rule that is inflexible to cope with changing macroeconomic circumstances. Some uncertainty exists regarding the structure of the macroeconomy. The natural unemployment rate could be greater or less than anticipated by the policy rule. A rule that is mistaken in its assumption of natural unemployment could cause money growth to be too strong or too weak.
A policy rule that overestimates natural unemployment causes money supply growth to be too slow. The economy consequently recovers too slowly from a recession. Alternatively, the policy rule might underestimate natural unemployment. This causes money supply growth to be too rapid and creates inflationary overheating. Some uncertainty also occurs on the size of the impact of stabilization policy. A monetary policy rule that overestimates its impact causes money growth to be too weak, which leads to slow economic growth. A rule that underestimates its impact on the economy cause money growth to be too strong, which triggers rising inflation.
In other words, a policy rule that misgauges the economy creates detrimental effects. Discretionary policy, of course, is also susceptible to misjudgments by the FOMC that could harm the economy. The Fed could erroneously adopt discretionary policy that is too weak, which leads to slow economic growth. The central bank might mistakenly adopt discretionary policy that is too strong, causing higher inflation.
A discretionary monetary policy, however, has one attribute that seems advantageous over the policy rule. A discretionary policy is not locked in place in the same way that a mathematical policy rule is fixed. A discretionary policy has more flexibility to respond to changing circumstances and misjudgments about the macroeconomic structure. The Fed, through discretionary measures, can readily adjust money supply and interest rates, based on new information, changing macroeconomic situations, or revised analyses.
A policy rule could also be revised. The process, however, may be more complex than discretionary policy. One of the main purposes of the policy rule, after all, is to make changes in policy more difficult to implement. The policy rule intentionally inhibits changes in money supply as a way to limit political interference. The process to modify a policy rule would probably require more steps than discretionary policy. Modification of the parameters in the monetary policy rule would presumably require some type of consensus or vote among the policy-rule makers, presumably the FOMC. Furthermore, if the policy rule is frequently changed, then the result is the same as discretionary policy. Shifts in discretionary policy can occur relatively fast based on the opinions of the policymakers. For these reasons, the flexibility of discretionary policy may be preferable to a rigid policy rule.