Discretion vs. Timeless Perspective under Model-consistent Stabilization Objectives

This paper contributes to a recent debate about the structural and institutional conditions under which discretion may be superior to timeless perspective. We show this is unlikely when the policy maker relies on a welfare-theoretic loss function obtained as a second-order approximation of households’ utility, even in the presence of features that should enhance the relative performance of discretionary policy-making in the baseline New Keynesian model. This result stands in contrast to the existing studies, whose analysis has typically relied on ad hoc welfare criteria that reflect neither households’ preferences, nor the degree of rigidity in price-setting.