NBER Working Paper #1079 February 1983 Rules, Discretion and Reputation in a Model of Monetary Policy Abstract In a discretionary regime the monetary authority can print more money and create more inflation than pcople expect. But, al though these inflation surprises can have some benefits, they cannot arise systematically in equilibrium when people understand the policymaker's incentives and form their expectations accordingly. Because the policymaker has the power to create inflation shocks ex post, the equilibrium growth rates of money and prices turn out to be higher than otherwise. There fore, enforced commitments (rules) for monetary behavior can improve matters. Given: the repeated interaction between the policymaker and the private agents, it is possible that reputational forces can substitute for formal rules Here, we develop an example of a reputational equilibrium where the out comes turn out to be weighted averages of those from discretion and those from the ideal rule. In particular, the rates of inflation and monetary growth look more like those under discretion when the discount rate is h obert j. Barro Economics D University of chi 1126 E. 59th Stree Chicago, Illinois 6063 (312)962-8923 David B. Gordon Economics Department University of Rochester Rochester, N.Y. 1462 (716)275-2627NBER Working Paper #1079 February 1983 Rules, Discretion and Reputation in a Model of Monetary Policy Abs tract In a discretionary regime the monetary authority can print more money and create more inflation than people expect. But, although these inflation surprises can have some benefits, they cannot arise systematically in equilibrium when people understand the policymakor's incentives and form their expectations accordingly. Because the policymaker has the power to create inflation shocks ex post, the equilibrium growth rates of money and prices turn out to be higher than otherwise. Therefore, enforced commitments (rules) for monetary behavior can improve matters. Given the repeated interaction between the policymaker and the private agents, it is possible that reputational forces can substitute for formal rules. Here, we develop an example of a reputational equilibrium where the out￾comes turn out to be weighted averages of those from discretion and those from the ideal rule. In particular, the rates of inflation and monetary growth look more like those under discretion when the discount rate is high. Robert J. Barro Ecdnomics Department University of Chicago 1126 E. 59th Street Chicago, Illinois 60637 (312) 962-8923 • David B. Gordon Economics Department University of Rochester Rochester, N.Y. 14627 (716) 275-2627