respectively The policymaker controls a monetary instrument, which enables him to select the rate of inflation, t, in each period. The main points of our analysis do not change materially if we introduce random discrepancies between inflation and changes in the monetary instrument. For example,we could have shifts in velocity or control errors for the money supply. Also, the policymaker has no incentive to randomize choices of inflation in the model e begin with a symmetric case where no one knows the benefit parameter b,, or the discount factor for the next period, q, when they act for period t Hence, the policymaker chooses the inflation rate · without observing either b. or similarly, people form their expectations <t policymaker's choice without knowing these parameters. Later on we modify this informational structure incretionary policy Our previous paper(Barro and Gordon, 1983)discusses discretionary policy in the present context as a non-cooperative game between the policymaker and the private agents. In particular, the po licymaker treats the current inflationary—7- = l/(].+r). We denote the mean and variance for by and respectively. The policymaker controls a monetary instrument, which enables him to select the rate of inflation, in each period. The main points of our analysis do not change materially if we introduce random discrepancies between inflation and changes in the monetary instrument. For example, we could have shifts in velocity or control errors for the money supply. Also, the policymaker has no incentive to randomize choices of inflation in the model. We begin with a symmetric case where no one knows the benefit parameter, bt, or the discount factor for the next period, when they act for period t. Hence, the policymaker chooses the inflation rate, without observing either b or Similarly, people form their expectations, ir, of the policymaker's choice without knowing these parameters. Later on we modify this informational structure. Discretionary Policy Our previous paper (Barro and Gordon, 1983) discusses discretionary policy in the present context as a non-cooperative game between the policymaker and the private agents. In particular, the policymaker treats the current inflationary