Linking to a Nick Crafts piece in the Financial Times:
The key lesson is that there is scope for monetary policy to stimulate the economy, even though nominal interest rates cannot be cut because they are already at zero. This means that there is an alternative to fiscal stimulus if the economy falls back into recession in 2012. Implementing a “cheap money policy” would, however, mean abandoning the current inflation targeting regime. Today’s equivalent of 1930s policy would imply formally adopting a price level target. The target could be to increase the price level by 15 per cent over four years and to convince the private sector that this will happen while interest rates are held down.
Although inflation has been high recently, the monetary policy committee stresses that it will soon return to and probably undershoot the 2 per cent target, implying that real interest rates remain higher than is desirable at present. The policy would not work if people thought that it would be reversed at the first sign of sustained recovery; the key to success in the 1930s was embedding the belief that prices would rise. The MPC would therefore need a new target that everyone expected to be achieved.
If we recognise that a price-level target worked in the 1930s, could it be equally successful today?
Circumstances may be less favourable now. Politicians would have to choose macroeconomic policy reform, whereas it was forced upon them in the 1930s. Consumers are burdened by debt and struggling to cope with falls in real disposable income, which is a notable contrast with the early 1930s. The eurozone crisis may deliver a bigger adverse shock than anything Britain faced after 1931. The output gap, whose magnitude is highly uncertain, may be much smaller than it was then, so that there is less scope for expansionary policies to raise real output. The chances of success would be greater if planning regulations were relaxed and we could once again envisage building 300,000 houses in a year, but that is politically too difficult...Emphasis added. Why not get out in front?