Matt Yglesias writes:
We right now have the capacity to produce more–much more–than has ever been produced before in the history of the planet. There are dozens of supply-side policies that could be improved in every country on earth, but that’s not a new fact about the world. What’s new is the lack of demand, the willingness of the key leaders in Tokyo, Frankfurt, Washington, Berlin, and now it seems London as well to tolerate stagnation and disinflation in the face of some of the most exciting fundamental new opportunities for human economic betterment ever.
You can take that quotation as a stand-in for the more general Keynesian AD views about the current recession.
First, I am fully on board with Scott Sumner-like ideas to boost AD through monetary policy, as is Yglesias and are many other Keynesians. There is no practical disagreement, but it remains an open question how effective such measures (or a bigger stimulus) would be.
Consider a simple model, in which uncertainty goes up, first because of the U.S. financial crisis, now because of Greece and the Euro and the open questions about Spain and how well Europe can cooperate. I'm not saying that's the only or even the prime cause of what's going on, it's simply an illustrative story.
With higher uncertainty, investors pull back, wait, and exercise option value. Aggregate supply declines, as does employment. As a result, aggregate demand declines too, and that includes real aggregate demand, not just nominal aggregate demand. Until the underlying uncertainty is resolved, the economy remains in the doldrums.
Note that there is still a case for fiscal policy, based on the idea of intertemporal substitution. With some labor unemployed, a sufficiently finely targeted fiscal policy can build a new road at lower social cost than before, by drawing upon unemployed resources. But even if that fiscal policy is a good idea, it won't drive recovery, at least not for plausible values of the multiplier.
There is also still a case for countercyclical monetary policy. As real AS and real AD are falling (see above), there is also downward pressure on nominal variables. Aggressive monetary policy, or for that matter the velocity-accelerating aspect of fiscal policy, can limit the negatives of this process and check the second-order fall in employment.
I'm all for countercylical AD management, noting that for other reasons I prefer monetary to fiscal policy in most cases and even if you don't agree with me there it suffices to note that the monetary authority moves last in any case.
That all said, the countercyclical monetary policy won't drive recovery either, or set the world right again, it just limits the damage. We still have to wait for the uncertainty to be cleared up.
Reading the Keynesian bloggers, one gets the feeling that it is only an inexplicable weakness, cowardice, stupidity, whatever, that stops policies to drive a more robust recovery. The Keynesians have no good theory of why their advice isn't being followed, except perhaps that the Democrats are struck with some kind of "Republican stupidity" virus. (This is also an awkward point for Sumner, who seems to suggest that Bernanke has forgotten his earlier writings on monetary economics.) The thing is, that same virus seems to be sweeping the world, including a lot of parties on the Left.
Romer, Geithner, Summers, et.al. know all the same economics that Krugman and DeLong and Thoma do. If a bigger AD stimulus would set so many things right, they'd gladly lay tons of political capital on the line to see it through and proclaim triumph at the end of the road.
Except they expect it would bring only a marginal improvement. And for that marginal improvement they have only a marginal desire to:
1. Raise the long-term national debt (if it's fiscal stimulus)
2. Put their reputations behind policies which might backfire or irritate Congress,
3. Put additional pressure on the independence of the Fed (if it's more aggressive monetary policy)
4. Wreck the current term spread of interest rates, which is a) making the short-term debt easy to finance, and b) restoring major banks to profitability rather quickly.
I still think they should try to do it — through more aggressive monetary policy — but it's a judgment call and that's why they are more or less staying put.
In general you should be suspicious of explanations which take the form of "if only the good people would all band together and get tough."