RULES RATHER THAN DISCRETION 477 for future policy selection. But as the simple example illustrated, this procedure is suboptimal Two examples follow The issues are obvious in many well-known problems of public policy For example, suppose the socially desirable outcome is not to have houses built in a particular flood plain but, given that they are there to take certain costly fiood-control measures. If the government,s policy were not to build the dams and levees needed for flood protection and agents knew this was the case, even if houses were built there, rational agents would not live in the flood plains. But the rational agent knows that, if he and others build houses there, the government will take the necessary flood-control measures. Consequently, in the absence of a law prohibiting the construction of houses in the flood plain, houses are built there, and the army corps of engineers subsequently builds the dams and levees A second example is patent policy. Given that resources have been allocated to inventive activity which resulted in a new product or process, patent protection. For thi few would seriously consider this optimal-control-theory solution as being reasonable. Rather, the question would be posed in terms of the optimal patent life(see, e.g., Nordhaus 1969), which takes into consideration bot he incentive for inventive activity provided by patent protection and the loss in consumer surplus that results when someone realizes monopoly rents. In other words, economic theory is used to predict the effects of alternative policy rules, and one with good operating characteristics is selected Ill. The Inflation-Unemployment Example The suboptimality of the consistent policy is not generally recognized for the aggregate demand management problem, The standard policy prescription is to select that policy which is best, given the current situation.This may seem reasonable, but for the structure considered, which we argue is a plausible abstraction of realiti, in unemployment such policy results n excessive rates of inflation without any redi The policy of maintaining price stability is preferable There are some subtle game-theoretic issues which have not been addressed here. Peleg and Yaari ( 1973) criticized Pollak's solution because sometimes it did not exist and proposed an alternative solution to the noncooperative intergeneration game. As ex ined by K and(1975b), in the language of dynamic games, Pollak lution and Peleg and Yaari the open- loop solution For policy selection, the poli dominant, and for dominant-player games, the open-loop solution is inconsistent(sec Kydland 1975a, 1975b for further details ). That is why Peleg and Yaari's solution was not considered here