The Economist magazine has a new article on the rising popularity of Market Monetarism, MMT, and Austrian economics. The article notes that all of these schools of thought have benefited immensely from the blogosphere and have each provided a critique of how macroeconomic policy has been conducted over the past few years. It was an interesting article, though as Scott Sumner notes the piece is wrong in its implication that nominal GDP targeting requires significant activism by the Fed. If implemented properly, nominal GDP targeting would require less activism since it focuses the Fed on a single, explicit mandate. In the case of Scott Sumner's nominal GDP futures targeting, this approach would actually put the Fed on automatic pilot. (It would also put many Fed economists out of work and make the Fed far less important, so do not bet on it happening!)
One point I want to stress here is that contrary to claims of some MMT advocates, the success of nominal GDP targeting does not depend on increased bank lending or on a naive belief in a simple money multiplier story where increased bank reserves lead to increased bank lending. In fact, the MMT emphasis on bank lending being influenced by capital considerations, credit worthiness of borrowers, and the demand for credit is entirely consistent with the Fed using a nominal GDP target to manage expectations such that portfolios are rebalanced in a manner that sparks a recovery. Here, bank lending responds to the improvement in current and expected economic activity brought about by nominal GDP targeting. This is how I explained the process before:
The ability of the Fed to influence total current dollar spending does not depend on banks creating more loans. Rather, it depends on the Fed's ability to change expectations so that the non-bank public rebalances their portfolios appropriately. Recall that a nominal GDP level target means the Fed makes an unwavering commitment to buy up assets until some pre-crisis nominal GDP trend is hit. As Nick Rowe notes, just the threat of the Fed doing this would cause the public to expect higher nominal spending growth and higher inflation. This change in expectations, in turn, would cause investors to rebalance their portfolios away from liquid, lower-yielding assets (e.g. deposits, money market funds, and treasuries) toward higher-yielding assets (e.g. corprate bonds, stocks, and capital). The shift into higher-yielding assets would directly affect nominal spending through purchases of capital assets and indirectly through the wealth effect and balance sheet channels. The resulting increase in nominal spending would increase real economic activity, improve the economic outlook, and thus further reinforce the change in expectations.
Bank lending would probably respond to these developments, but it would not be driving them. It is interesting to note that FDR did something similar to nominal GDP level targeting in 1933 and it sparked a sharp recovery that lasted through 1936. Bank lending, however, did not recover until 1935. Bank lending, therefore, was not essential to that recovery. That may be less true today, but in any event the key point here is that if bank lending does increase it would do so as a consequence of the improved economic conditions brought about by the change in economic expectations.
There is more here on how this transmission mechanism works. The real critique, then, is whether a change in nominal expectations can really affect current spending decisions by firms and households. I have an earlier post that shows inflation and nominal GDP expectations (as proxied by a survey of forecasters) do in fact influence spending decisions. Josh Hendrickson and I also show in this recent working paper that shocks to inflation expectations cause households to adjust their portfolios in the manner outlined above. Finally, as shown by Gautti Eggertson, a sudden change in nominal expectations was also key to FDR's 1933-1936 recovery. If the MMTers (and Austrians) could come to accept this evidence, then we could truly have a deficient aggregate demand lovefest.