Lucas's slides tell a nice story, and the general idea is to draw a parallel between the Great Depression and the recent recession. This is not a talk based on original research, but draws ideas mainly from the work of others. Lucas's account of the Great Depression follows Friedman and Schwartz's Monetary History and Cole and Ohanian (see this Wall Street Journal article for a summary of their research). Basically, the Fed did not act appropriately to offset the monetary contraction culminating in the massive banking failures and panics of 1933, and the recovery was prolonged by various New Deal policies.
Lucas's narrative for the recent recession in part follows Gary Gorton (see this interview for example). In contrast to the Great Depression, there was no disruption in payments, but in Gorton's view there was something akin to a bank run phenomenon in the shadow banking sector. But, in Lucas's view, the Fed did the right thing in this instance, acting to mitigate the effects of the financial panic.
I could find plenty of reasons to quarrel with Lucas's story. The Friedman-Schwartz quantity-theory-of-money narrative misses the the effects of lost intermediation services; Gary Gorton's Diamond-Dybvig shadow-bank-run story may not hold water; Cole and Ohanian downplay financial factors to a fault; etc.
However, what Krugman and friends focus on is summarized in Lucas's conclusion:
Lucas sees this as another parallel to the Great Depression. The Fed has now done all it can, so what is impeding the recovery? Possibly, just as in the Great Depression (according to the Cole-Ohanian narrative), it's the government again.
• Throughout this talk, I have defined recession as deviation from a 3% growth trend.
• Implicit assumption is that economy will get back to old trend line–only question is how long it will take.
• Is this really the case?
• Know that European economies have larger government role and 20-30% lower income level than US.
• Is it possible that by imitating European policies on labor markets, welfare, and taxes U.S. has chosen a new, lower GDP trend?
• If so, it may be that the weak recovery we have had so far is all the recovery we will get.
Now it's clear, at least to me, that Lucas is just throwing out an idea for discussion. Lucas is a scientist, of course, and he's not going to commit himself to some view without solid research to back it up. That's why he uses words like "is it possible..." If I were looking for a reason for the sluggishness in the current recovery, blaming the US government would not be the first thing that would come to mind, but it is not silly for Lucas to be asking the question. In any case, Lucas's talk is at least thought-provoking, and frames the issues in a nice way.
Now, here's what Krugman has to say about it:
there’s a good reason Lucas won’t even consider the obvious explanation in terms of a shortfall in demand. More than 30 years ago, in a burst of radically premature triumphalism, Lucas and his colleagues declared the “Death of Keynesian economics”. As cited by Greg Mankiw (pdf), Lucas wrote that Keynesian theorizing was so passe that people would giggle and whisper if it came up in seminars.Now, as if this was not already abundantly obvious, Krugman is seriously confused.
Since then, as is obvious to everyone but the hermetic inhabitants of the freshwater world, the attempt to explain business cycles in terms of rational expectations and frictionless markets has failed; and Keynesian economics continues to be very useful. But to concede that, to even consider the possibility that we’re in a demand-shortfall slump of the kind Keynes diagnosed, would be an incredible comedown for Lucas.
So he can’t and won’t consider the possibility.
The Mankiw paper that Krugman links to is this one. This is an interesting piece of intellectual history, as that paper looks like a precursor to Ball and Mankiw's Sticky Price Manifesto. Actually, Lucas's comments on the Ball-Mankiw paper are excellent reading in this context, and apply directly to how Krugman thinks about the world. Here are some of the more juicy passages:
The cost of the ideological approach adopted by Ball and Mankiw is that one loses contact with the progressive, cumulative science aspect of macroeconomics. In order to recognize the existence and possibility of research progress, one needs to recognize deficiencies in traditional views, to acknowledge the existence of unresolved questions on which intelligent people can differ. For the ideological traditionalist, this acknowledgement is too risky. Better to deny the possibility of real progress, to treat new ideas as useful only in refuting new heresies, in getting us back where we were before the heretics threatened to spoil everything. There is a tradition that must be defended against heresy, but within that tradition there is no development, only unchanging truth.And,
A few years ago, one of my sons used the Samuelson-Nordhaus textbook in a college economics course. When I visited him, I looked at the endpaper of the book to see if actual GNP was getting any closer to potential GNP than it had been in the edition I had used many years earlier. But the old chart was gone, and in its place was a kind of genealogy of economic thought, with boxes for Smith and Ricardo at the top, and a complicated picture of boxes connected by lines, descending down to the present day. At the bottom were three boxes: On the left, a box labelled “Communist China”; in the center, and slightly larger than the rest, a box labelled “Mainstream Keynesianism.” The last box, on the right, was labelled “Chicago monetarism.”In Lucas's commentary you can pretty much substitute "Krugman" for "Ball and Mankiw" and it makes perfect sense.
Times change. Accordingly, to Ball and Mankiw, Chicago monetarism (or at least Milton Friedman) now shares the middle, mainstream box, and there is a new group for the right-hand box, to be paired with the Chinese communists. But the tradition of argument by innuendo, of caricaturing one’s unnamed opponents, of using them as foils to dramatize one’s own position, continues on. I am sorry to see it perpetuated by Ball and Mankiw, and I hope they will put it behind them and return to the research contributions we know they are capable of making.