My beef with market monetarism early on was that its proponents seemed to be saying that the Fed could always hit whatever nominal GDP level it wanted; this seemed to me to vastly underrate the problems caused by a liquidity trap. My view was always that the only way the Fed could be assured of getting traction was via expectations, especially expectations of higher inflation –a view that went all the way back to my early stuff on Japan. And I didn’t think the climate was ripe for that kind of inflation-creating exercise.
Seemed to be saying? Sumner, especially, has been emphasizing the importance of expectations since the day he started his blog, and long before. Further, he probably writes about how it is important to generate expectations of higher inflation more often than he writes about how it is important to generate expectations of higher level of nominal GDP. I know, because I take him to task every time he makes that mistake.
While it is true that expectations of higher inflation in the future can raise nominal GDP now, and could also create inflation now, expectations of a higher level of real output in the future can also raise nominal GDP now, and create more real output now. Sumner's actual view is that expectations of an increase in the flow of expenditure on output in the future will generate an increase in the flow of expenditure on output now. To what degree firms either now or in the future respond to that by raising either prices or production is not essential to the process.
But, of course, an increase in production would be better than an increase in prices. My own view is that an increase in production would be good and an increase in prices would be bad--a necessary evil to maintain the regime of nominal GDP targeting.
On the other hand, I was much more guilty of ignoring the key role of expectations early on. The relationship between expected future nominal GDP and current nominal GDP played little role in my thinking. I certainly downplayed the problems associated with a liquidity trap.
On the other hand, I have never assumed that modest changes in the quantity of money would generate whatever nominal GDP the Fed wants. I have always thought that quantitative easing in heroic amounts might be needed to keep nominal GDP on target in a situation what would otherwise develop into a Depression. Something causes a large drop in the money multiplier and velocity, so a large, perhaps very large, increase in base money would be necessary.
What is the relationship between expected inflation and nominal GDP targeting? There is no need for the Fed to say that it wants more inflation. However, it does need to be willing to accept higher inflation if that is the consequence of nominal GDP rising to the target growth path. The expectation that the Fed would respond to any increase in inflation that occurs by giving up on the target for nominal GDP would make it difficult and perhaps impossible to reach the target growth path.
The Fed cannot play at nominal GDP targeting. It must adopt the new regime. It should adopt the new regime--it is better.