We were less wealthy than we thought we were.
Call me an AD-denier, but I still think the basic issue here is that you can’t consume more than you produce. Production exists to satisfy demand, but at the same time demand is limited by production. We had a long boom built on the notion we could boost demand and thus supply and thus demand again in a virtuous cycle, and now we are seeing the cycle work in reverse as demand/supply seek their natural levels.
One way to justify this model is in terms of multiple equilibria, and that we have been walking (bouncing our heads?) back down the escalator. Arguably for the United States this downward bouncing is over. Along the way we are sending signals about the quality of our institutions and thus shaping the course of the future.
In this model there is still a useful role for fiscal policy. For one thing, fiscal policy can smooth that ride down the escalator, by spreading the losses out over time, at the cost of future debt of course. This may be needed if only to make the political economy of decline less bitter; see Spain and Greece. Nonetheless fiscal policy cannot make up for the output losses at will. We are not standing in an IS-LM diagram where the difference between “what we have” and “what we could have” is thwarted only by some supposed Austerians who won’t shift the proper curve and yet somehow have taken over some of the biggest spending social democratic, insider-leaning governments in world history. The IS-LM approach fits in nicely with the view that policy improvement is all about yakking about the obstructionists. Instead, policy is also about rebuilding trust, not just maintaining ngdp on a decent keel.
There is another possible role for fiscal policy, as there usually is in models of multiple equilibria. If you ran some super-duper fiscal policy, and invented the flying car, a cure for cancer, and other marvels, the market might suddenly latch its expectations on to a much more positive scenario. There could be a significant upward bounce to a much higher equilibrium of output and employment. In any case, the quality of fiscal policy matters, and Keynesian ditch digging probably doesn’t do much for inferences about institutional quality and for the selection of multiple equilibria. “Spend the money, anywhere” is in my view a deeply pernicious attitude, somewhat akin to thinking you can create a good NBA team, with a strong ethic for quality and work, by tanking for better draft picks at the end of every season. But no, the internal ethic matters and cannot be first destroyed and then recreated at will. Good teams don’t usually work that way, and neither do good fiscal policies.
Right now we Americans are building back up to better equilibria, slowly, by showing that our economic institutions are not totally crummy. This process can take a good while, but in fact our recovery is going better than many people believe. The eurozone is far — very far — from being on that kind of rebuilding track.
There is plenty of talk about various commentators don’t understand the lessons of Econ 101. There is a reason why we teach classes beyond 101, and why we spend so much time studying institutions and the theory and empirics of public choice.