JOURNAL OF POLITICAL ECONOMY t,given the current situation. The indifference curves imply that the socially preferred inflation rate is zero, which seems consistent with the publics preferences. We of course recognize that inflation is a tax on reserves and currency, and a more informed public might prefer some positive or negative inflation rate. If so, x need only be interpreted as deviation from the optimal rate. The outcome of a consistent policy selection clearly is not optimal. If the policymakers were compelled to maintain price stability and did not have discretionary powers, the re- sulting equilibrium would have no higher unemployment than the con sistent policy. The optimal equilibrium is point O, which lies on a highe indifference curve than the consistent-equilibrium point C t is perhaps worthwhile to relate our analysis to that of Taylors (1975), in which he found that the optimal monetary policy was random in a rational-expectations world. Similar results would hold for our prob- lem if uncertainty in the social objective function had been introduced Both for his structure and for ours, the optimal policy is inconsistent, and consequently it is not optimal for the policymaker to continue with his original policy rules IV. Consistent Planning for the Infinite Horizon The method of backward induction cannot be applied to infinite-period problems to determine a consistent policy because, unlike the finite period problem, there is no final period with which to begin the induc tion. For recursive structures, however, the concept of consistency be defined in terms of policy rules. Suppose that the economy at time t can be described by a vector of state variables yr, a vector of policy variables Tr, a vector of decision variables x, for the economic agents and a vector of random shocks e, which are temporally independent The movernent over time of these variables is given by the system of y+1=F(y1,r;x2E1 Let the feedback policy rule for future periods be For certain structures, rational economic agents will in the future follow a rule of the form d(ys;∏ It te that changes in policy rule ni change the func tional form of d a point convincingly made by Lucas(1976)in his critique of current econometric policy-evaluation procedures. The decisions of agents in the current period will have the form d(y2r;∏)