Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Discretionary monetary policy

If the central bank is able to decide on the interest rate it sets without having any well-defined objective, that monetary policy is said to be conducted by discretion (in contrast to inflation targeting in the preceding section, which is a type of monetary policy rule).

Before 1992, monetary policy in the UK was by discretion; after that, the country moved toward inflation targeting. 1992 was a tough year for the UK economy because it was forced out of the Exchange Rate Mechanism (ERM), which was the precursor to the euro. The ERM tried to ensure that the exchange rates between different European countries didn’t fluctuate too much.

Discretionary monetary policy was somewhat of a disaster in the UK – if you’re old enough, you may remember inflation of over 25 per cent in 1975 (ouch!).

The trend over the past few decades has been away from discretionary monetary policy towards some kind of monetary rule, typically inflation targeting. Interestingly, the Federal Reserve in the US only formally announced an inflation target of 2 per cent in 2012 – much later than most other developed economies – although it was understood that they were informally targeting inflation for some time.


Sometimes repay your debts

Governments can often rack up mind-bogglingly large amounts of debt. To give you some idea, as of 2014, US government debt was more than $17 trillion (that is, 17 followed by 12 zeros!). UK government debt was over £1 trillion, and Japanese government debt was around $10 trillion. These debts must be paid from taxes raised from current residents or taxes on future generations.

Not paying its debts can appear tempting for a highly indebted

country, because that huge liability disappears and presumably the citizens can now enjoy life debt free. If policy makers are free to decide whether to repay debts at their discretion, they may pay them back sometimes and not at other times. Your intuition is probably telling you that this doesn’t sound like the best plan – and your intuition is spot-on.