I agree with most of this critique of Krugman (and the "stimulus") but I wanted to quibble with this:

Krugman is very concerned that the liquidity trap we’re arguably in will degenerate into a sticky and persistent deflationary spiral, with far lower output for years to come (an American “lost decade”).

The President faces a different trap. By believing the mathematics and not the people, he’s come out in favor of a huge spending plan that runs deeply counter to what nearly every American now feels deep in her marrow: that this is a time for saving, not for borrowing and spending.

And there’s something very important about this that even an economist needs to account for. Because the overall mood of the country prohibits a quick return to spending and investment, the multiplier effect of the stimulus will be muted. (my emphasis)

Does the mood of the country prohibit a quick return to spending and investment?  I can easily make sense of the idea that people want to spend less.  Apply the following model: People want to consume, annually, a certain percentage of the lifetime net worth.  That net worth has fallen sharply due to reduced housing and stock prices, and also maybe reduced prospective earning opportunities.  So they want to consume less.

But investment is a way of transferring resouces from the present to the future.  You put solar panels in your roof.  Up-front cost now, lower energy bills for years to come.  You build a factory.  Up-front costs now, revenues from the sales of products for years to come.  People should want to do more of this at a time when they are desperate for stronger balance sheets.

I don't think the obstacle to investment is "the mood of the country."  It is (a) the volatility of prices and other macroeconomic variables (employment, GDP) makes it harder to calculate the value stream that investments will generate, (b) increased political risk, as the explosion of present and expected future government interference in the economy in the past few months makes people suspect that their investments will be directly or indirectly expropriated, and (c) the fact that so many investment-type assets are now for sale cheap through the devalued stockmarket (why build a factory or a fleet of trucks when you can buy companies that have these things at half of what they cost two years ago?)

Comments

[ms]

I think there's a wait and see attitude right now. Everything seems so uncertain that everyone, both businesses and individuals, want to see how things play out before taking on debt and risk. That seems to be what you're saying as well?

[Nathan Smith]

Well, yeah, more or less. That is, (a) and (b) deal with uncertainty; (c) is something different. But I'm also trying to break down sources of uncertainty, to try to shed light on what policymakers might be able to do. If political risk is the problem, the most important thing would be for policymakers to create credible commitments to continuity in economic policy. Long-term deficit reduction is essential, because otherwise the fears will be that the government will either devalue its debts through deflation, or else raise taxes sharply. Investors are particularly vulnerable to the latter move, since sunk investments can easily be confiscated, directly or by all sort of indirect means.