Discretionary policy

Discretionary policy is a term used to describe macroeconomic policy based on the ad hoc judgment of policymakers as opposed to policy set by predetermined rules. For instance, a central banker could make decisions on interest rates on a case by case basis instead of allowing a set rule, such as the Taylor rule, determine interest rates.

Discretionary policies are similar to "feedback-rule policies" used by the Federal Reserve to achieve price level stability. "Discretionary policies" refer to actions taken in response to changes in the economy, but they do not follow a strict set of rules, rather, they use subjective judgment to treat each situation in unique manner. In practice, most policy changes are discretionary in nature. Policy makers use auto stabilizers to adjust the aggregate demand.

"Discretionary policy" can refer to decision making in both monetary policy and fiscal policy.

According to Milton Friedman, the dynamics of change associated with the passage of time presents a timing problem for public policy. The reason this poses a problem is because a long and variable time lag exists between: 1. The need of action and the recognition of that need 2. The recognition of a problem and the design and implementation of a policy response; and 3. The implementation of the policy and the effect of the policy (Friedman 1953: 145).

It is because of these lags that Friedman argues that discretionary public policy will often be destabilizing. For this reason, he argued the case for general rules rather than discretionary policy.