After reading Kevin Hassett’s piece today about politicians treating PE firms as pornographers, I got to perusing Ed Prescott’s 2004 Nobel-acceptance lecture. And that got me thinking about the merits of “rules rather than discretion” in government policies.
As Prescott points out, suppose that nominal wage is set such that real wage is too high. You can, of course, undo this, ex post, via inflation (make people’s money worth less), but if people anticipate that from central banks that will lead to even more inflation and worse distortions. The solution, Nobel-winner Prescott argued, was an independent central bank committed to low inflation.
I’m fond of these sort of exercises, trying to imagine how others will respond to varying policies. There is a great exercise in that sort of thing captured by what is usually called “the numbers game”. Assume that all ten-zillion readers of this blog must choose an integer number between 0 and 100. What will two-thirds of the average number chosen be?