THE SELECTION OF MACROECONOMIC POLICY CONSTITUTIONS IN THE PRESENCE OF STRUCTURAL CHANGE AND RULE CHANGE COSTS

This dissertation examines the choice of policy constitutions when the economic structure can change over time. Starting from a static economic model where the presence of labor distortions causes time consistent discretionary policy to create too much inflation, several alternative constitutions are investigated and their performance is compared. The three basic constitutions studied are: the political/discretionary constitution where electoral competition forces monetary authorities to act as if they are maximizing ex post social welfare; the fixed tenure rule where rules are changed at fixed intervals; and the switching rule where rule changes occur when the social benefits of doing so exceed the social costs.;Besides the three basic constitutions, two extensions are considered. A constitution is examined where the monetary authority can control the agenda. Here social welfare may actually increase when the costs of changing rules increases. Furthermore, a constitution is investigated where political parties have their own policy preferences. Using rational choice by the voters, a partisanship model is constructed where the probability of any particular party winning the election is endogenous. Because wage contracts are set a period in advance, voters by choosing one party over another are implicitly choosing the level of surprise inflation which enhances the effectiveness of stabilization policy.;The nature of structural change is very important to the welfare comparison of the alternative constitutions and to the characteristics of these constitutions. When inflation rate preferences change, society may choose to let the monetary policy be controlled by a politically motivated monetary authority. The politically motivated monetary authority has an incentive to adjust instantaneously to changes in social preferences while the rule constitutions are burdened by adjustment costs. However, when the labor distortion is changing over time, a rule will always be preferred to the political/discretionary constitution and will imply a monetary authority that cares more about inflation than society does.