Much of the recent fiscal stimulus will not be spent until after the economy returns to full employment.

I have to disagree here. The current stimulus package will all be spent by the end of 2010. I know of no one who is forecasting unemployment below 8% by then and many who are forecasting unemployment above 8% until 2012-14. If you know of someone who is predicting a return to full employment (however you want to define that) by the end of 2010, I’d love to see it.

I agree that relative prices also matter, and in a perfect world they would reflect people’s genuine preferences. But I think that an explicit NGDP target would not actually be that damaging to relative prices, particularly if it were rigorously adhered to. Even Hayek argued that stabilizing NGDP is important, and some modern Austrian economists, who are clearly sensitive to the relative prices issue, endorse the idea. The real problem for relative prices comes when you try to get a little boost from a monetary surprise, above and beyond the stated NGDP target.

I think the idea you’re referring to is a liquidity trap. The simple version of the liquidity trap story is that during a bad recession, money demand becomes highly elastic. Injections of money just get hoarded and never make it to the loanable funds market, so interest rates don’t go down. There is a related story in which nominal interest rates are already at zero and cannot go lower. If monetary policy can’t affect the interest rate, the argument goes, then it is ineffective. I don’t buy either of these stories. First, the hoarding argument is overstated. A more sophisticated version is that people invest in lower risk assets, which I think is probably true. But even this is not that important because, second, interest rates are not the only channel through which monetary policy affects the economy. If the Fed printed a billion dollars and gave it to me, I would spend some money, regardless of what interest rates are. The reality is that the Fed has lots of tools to stimulate the economy, even if the injections don’t go directly to the market for loanable funds.