Changes in UK monetary policy: Rules and discretion in practice

In October 1992, following sterling's departure from the Exchange Rate Mechanism, Britain adopted a new framework for monetary policy. That comprised two components: first, an explicit target for inflation, and, second, institutional changes designed to give greater influence to the Bank of England by increasing the transparency and openness of the process by which interest rates are set. This paper analyses those changes from the perspective of the debate on rules versus discretion, and argues that an appropriate design of institutional arrangements can provide incentives for central bankers to pursue the first-best state-contingent monetary policy.