Paul Krugman:

Economics in the Crisis: The disaster came…. The immediate problem was a huge shortfall of demand, as the private sector moved from large financial deficit to large financial surplus. To avoid terrible effects on output and employment – effects that would only magnify the problems of excess leverage – we needed not just a rescue of the financial system but also strong government action to support demand while the wreckage was cleared…. Large-scale unconventional monetary policy, which in a zero-bound economy has to work largely through inflation expectations. But the more proximate tool, with the greatest known effectiveness, was fiscal policy, especially increased government purchases of goods and services.

Anyone who knew the IS-LM model understood that. But too much of the economic profession had lost the hard-won understanding of earlier generations. So instead of a common call for action, we got acrimonious argument, with quite a few economists essentially acting as spoilers, undermining the credibility of those trying to get governments to do the right thing. And as I said, to a remarkable extent the “learned” arguments against government action were actually repeating fallacies like Say’s Law and the Treasury View that had been thoroughly refuted in the 1930s. Should we be surprised, then, that economic policy makers, after responding fairly effectively to the banking crisis, proceeded to lose the thread?

What happened, in fact, was that to a large extent policy makers ended up going for economic doctrines that made them feel comfortable, that corresponded to the prejudices of men not versed in economics….

Government officials who hang out with businessmen – and almost all of them do – naturally tend to be attracted to views that put business confidence at the heart of the economic problem. Sure enough, belief that one should slash spending even in a depressed economy, and that this would actually promote growth because it would have positive effects on confidence, spread like wildfire in 2010. There were some economic studies used to justify the doctrine of expansionary austerity – studies that quickly collapsed under scrutiny. But really, the studies became popular because they suited the prejudices of politicians, prejudices that would have been totally familiar to Herbert Hoover or Heinrich Brüning.

http://krugman.blogs.nytimes.com/2012/03/05/economics-in-the-crisis/


http://delong.typepad.com/sdj/2012/06/economics-in-the-crisis-nytimescom.html