According to Krugman, here's the problem:
Basically, in the face of what I would have said is obviously a massive shortfall of aggregate demand, we’re seeing on all-out attack on the very notion that the demand side matters.As I've said before, on more than one occasion, "shortfall in aggregate demand" has no meaning, either in fully-articulated New Keynesian models, or any other modern models of macroeconomic activity. If the statement has no meaning in terms of the theory, we can't observe the shortfall empirically either. Of course, Krugman is thinking about a Keynesian Cross model, which is not what modern macroeconomists (of any stripe) work with. If you buy into the Keynesian Cross, what recession would not be a shortfall in aggregate demand?
Then, we get:
This isn’t entirely new, of course. Real business cycle theory has been a powerful force within academic economics for three decades. But my sense is that the RBC guys had very little impact on public or policy discussion, simply because what they said seemed (and was) so disconnected from actual experience.You could actually say more than this. Real business cycle theory is based on work on economic growth by Solow, Cass and Koopmans, which stretches the "powerful force" back more than five decades. Real business cycle theory, in its original form was hardly "disconnected from actual experience," indeed part of the influence and strength of the approach came from its quantitative nature and the attempt to confront models with the data. Now, you won't find many practitioners today who actually use the RBC framework in its original form. However, what it became was New Keynesian theory (and applications), with the addition of sticky wages and prices with monopolistic competition; and any number of branches of the macroeconomic literature (asset pricing, credit markets and bankruptcy, for example) that use competitive heterogeneous agent constructs. To say that the "RBC guys" had no influence on policy is false. People who I might think of as RBC guys are now running Federal Reserve Banks, for example, and the ideas permeate policy discussion.
Krugman seems to think that people are out to attack the Keynesian Cross, but that certainly is not anyone I know. Most of them don't think much about it. Apparently the attacks are coming from the commenters on Krugman's blog posts. Well, good for them! Krugman's defense is that the Keynesian Cross has been in the Econ 101 textbooks for 62 years. I have also heard that a majority of Americans believe that angels exist.
Krugman goes on by resurrecting his babysitting co-op story. To me, the lesson from this story is that the designers of this co-op did not do a good job. About 25 years ago, my wife and I participated in a babysitting co-op in Minneapolis that seemed to work fine, without anything that looked like Keynesian intervention. I don't get it.
Anyway, we know how this will finish off. Krugman will be alarmed - but sad.
Seriously, though, this is truly sad — and dangerous. Demand-side understanding, in my view, played a big role in helping us avoid a full replay of the Great Depression; if enough people had shared that understanding, we might have avoided even the minor-league Depression we’re going through. But willful ignorance is on the march — and the odds are that we’ll handle the next crisis very badly.I think Krugman and I have different ideas about where the ignorance resides.
1. People who think that Old Keynesian (or more accurately, the Hicksian interpretation of Keynes) economics has something to say typically argue that the "demand deficiency" is obvious by looking out the window. But the fundamental source of inefficiency in their framework comes from sticky wages and prices. To make a good case that Old Keynesian forces matter for recent history, the Old Keynesians should be showing us direct evidence of the sticky wages and prices, as they relate to the current state of the economy.
2. What I think Krugman is worried about is that, if the non-Keynesians are correct then somehow we no longer have a role for the government. Nothing could be further from the truth. Not accepting Keynes as your savior does not mean that you think the government's role should be very narrowly defined, that you don't care about the poor, or that you are a Republican.