According to the time inconsistency model article published by the 2004 Noble prize winners, Finn Kydland and Edward Prescott (1977), reveals that the use of discretionary monetary policy will lead to equilibrium with an ‘inflation bias’. In order to explain and determine how this fact was reached, we have to first explain what time inconsistency is. Time inconsistency can be referred to as when a law or rule that initially seemed most favourable at one point in time becomes unfavourable later in the future or the difference before the event and after the fact. A good example is governments none negotiating with terrorist rule. Government’s announces this rule with the primary intention to discourage and influence terrorist expectations/behavior. But once hostages are taken, the whole country and mostly the whole world are watching putting a larger weight on the government shoulder to make compromise to obtain the hostages release. So unless the policymakers are credibly committed to the policy, the announcement holds no ground. As Kydland and Prescott explained, the central bank's desire to cut unemployment to the natural rate will lead to time-inconsistent behaviour.

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Appendix 1

Discretion arises from the problem of time inconsistency of policy and this also leads to a ‘credibility’ problem that starts when the government is trying to use monetary policy to reach its desired output level between inflation and unemployment. It was concluded that ‘Rules’ should be put into place rather than ‘Discretion’ because with discretion, the government given the opportunity will take advantage while if there are implemented rules, there will be not cheating and no credibility issue. Inflation and unemployment are inversely related and the government wants to achieve and maintain the possible minimum rate of unemployment i.e. to get unemployment to its