macroeconomics, crisisPaul Krugman says that the reason for the current crisis is a lack of demand. One of his main suggestions is a higher inflation target, massive stimulus spending or a combination of both.
Is his analysis and proposed remedy widely supported academically. If not, then what are the standard objections and on what evidence are they based on?
His analysis goes back at least as far as Keynes, and has a lot of support (and opposition) in the literature.
Some of the standard objections include assertions that fiscal stimulus is inflationary without being productive; that it's inefficient compared to the alternatives; that stimulating demand without fixing private balance-sheets is at best only a short-term fix.
Richard Koo of Nomura securities argues persuasively that Japan avoided depression in the 1990s and noughties - it avoided repeating the American 1930s depression - through large fiscal stimulus, and by starting to fix private balance-sheets.
Koo identifies that the bursting of an asset-price bubble that had been debt-financed, causes a recession that is unlike other recessions: such balance-sheet recessions need something other than monetary stimulus. In the (probably apocryphal) words of Keynes, trying to stimulate demand through monetary stimulus in these circumstances is "like pushing on a piece of string"
See also the related question: What is the optimal policy response for a country experiencing a liquidity trap?
Krugman talks a lot about contentious politics, but in this case, it’s unremarkable economics.
Everyone agrees that lowering interest rates is a great way to put the economy back on the road to full employment. But, interest rates are already at zero, and we can’t make them negative, so that option is not available to us.
But increasing inflation will essentially make interest rates negative. It has other “benefits” as well, such as cutting real wages, which by itself will increase employment. But while this accomplishes short term goals, it has a terrible long term price that many are unwilling to pay.
I think that most economists would agree with “massive stimulus spending” if it weren’t for the fact that such stimulus spending would be politicized, going to the politically connected (like Solyndra). Few economists are worried about America debt right now, but politically, it’s a difficult issue.
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