Arnold Kling posed the following hypothetical:
Consider the following thought experiment. Call what we actually did–the bailouts, the stimulus, the actual path of monetary policy–plan A. Suppose that in March of 2008, when folks were contemplating a bailout of Bear Stearns, the Fed instead had gone with Plan B, in which Ben Bernanke says, “Folks, it looks like there is going to be some heavy weather ahead on Wall Street. A lot of firms are in shaky situations. I want everyone to know that, no matter what happens, (a) we are not going to do anything to assist any individual firm; and (b) we are not going to allow nominal GDP to fall below the path in our forecast, which calls for an increase of 5 percent per year.”
. . .
Would the market response to Bernanke’s promise to maintain nominal GDP have resulted in the economy remaining closer to full employment? I can think of three channels.
1. Wage rates. If anything, workers who believed the hypothetical promise to maintain nominal GDP would have been less likely to make wage concessions. Thus, this goes the in the wrong direction.
If workers start making wage concessions then you’ve lost the war. They’ll never be big enough. Get ready to be voted out of office and replaced by another government. Nominal wage concessions are the last thing you want. And I agree with Arnold that nominal wage gains might have actually been slightly higher under 5% NGDP targeting adopted in early 2008—perhaps 4% instead of 3%. But here’s what matters, wages/NGDP would have risen far less in 2008. As it is, the ratio rose by about 7% (3% wage gains and 4% NGDP decline from 2008:2 to 2009:2.) That sudden increase made high unemployment almost inevitable. With a 5% NGDP target and 4% nominal wage gains, the ratio would have actually fallen about 1%, resulting in much higher employment levels than what actually occurred.
One of the most important goals of NGDP targeting is to make nominal wage growth stable, so that any needed adjustments in real wages would occur via price level changes.
PS. I agree with Arnold’s claim that 3% NGDP growth in 2009 would have been dramatically better than what actually occurred. Why didn’t the Fed do at least that much stimulus?