In my last post I argued that nominal GDP targeting does not depend on bank lending to work. Instead, its success depends on the Fed using the nominal GDP target to manage expectations such that the portfolios of the non-bank sector rebalance in a manner that shores up aggregate demand. Bank lending may respond to this process, but is not essential to it. I mention this again because I just came across an interesting paper by Edward Nelson and David Lopez-Salido that lends support to this view. The authors show that, contrary to the claims of Reinhart and Rogoff (2009), recoveries following financial crises are not inherently weaker. Rather, they depend on policy. From their abstract [emphasis mine]:
We find that the regularity that recoveries are systematically slower in the aftermath of financial crises does not hold for the postwar United States. The pace of the expansion after recessions seems to reflect deliberate aggregate demand policy. A weak lending outlook does not appear to pose an insurmountable obstacle to the functioning of stimulative aggregate demand policies.
The implication of this paper and my previous post is that the weak economic recovery is a failure of policy to fully restore aggregate demand, nothing more. All the talk about how recoveries following financial crises are typically weaker and that we are now in a balance sheet recession distracts from this fact. There was nothing inevitable about the Great Recession and subsequent lack of robust recovery. A nominal GDP level target is the best way to fix this policy failure.
P.S. Edward Nelson also has a recent paper on Milton Friedman that provides a nice discussion of the portfolio channel.