Dynamic Macroeconomics

Figure 15.6
Convergence of real output for different values of the accelerator.
15.3 The Theory of Discretionary Monetary and Fiscal Policy
The potential for monetary and fiscal policy to achieve full employment is
clear in Keynesian models. The question that arises relates to the appropriate
use of monetary and fiscal policy. This question was first posed in the
important contribution of Tinbergen [1952], who distinguished between
targets and instruments of (macro) economic policy. Tinbergen argued that
as long as the policy authorities had as many independent policy instruments
as they had policy targets, they would be able to fully achieve their targets by
using one policy instrument for each target. If they had fewer instruments than
targets, then they would not be able to achieve all their targets
simultaneously. Moreover, if the policy authorities had access to an
econometrically estimated model, they could calculate, with relative
precision, the appropriate response of policy instruments to stochastic shocks
that shift the economy away from the targets of the authorities.
Tinbergen’s ideas were further developed by Theil in a series of
contributions (Theil [1954, 1956, 1964]). Theil analyzed how to optimally
adjust policy instruments to calculate policy responses, and these ideas
gradually became operational through the development of large-scale
Keynesian macroeconometric models, which were used for both forecasting
and policy evaluation.
The policies that are decided in this way are often referred to as
discretionary policies, as opposed to rules-based policies, according to
which the path of policy instruments is not determined at the discretion of
governments but on the basis of restrictive policy rules.
In effect, Keynesian models and the Tinbergen-Theil theory of economic
policy tilted macroeconomic policy in the direction of discretion rather than
rules.