In next Sunday's NYT Magazine, Krugman takes on Bernanke for not doing more to push along the recovery - things like pumping more money into the economy. What Dr. K does not understand is that what the economy is suffering from is not some technical imbalance like a vitamin deficiency. The economy is suffering from a deep fundamental problem - we are not increasing our output sufficiently to raise our standard of living. What's worse is that the growth we've had over the last 10 - 30 years was largely fraudulent, an illusion concocted by debt (and I'd argue all the growth of the last decade was completely fraudulent). Thus, our standard of living exceeds what we have truly earned and we continue to pile on debt just to maintain the ruse.
This is why the middle class has been stagnant for decades now - there's been no real fundamental growth. If economic growth were organic and true, then the resulting affluence would accrue to everyone. But since the average person is not any more productive in any real sense, the increased affluence has largely gone to those who have excelled at figuring out how to finagle the systemic leverage to their advantage - and to that small segment of the population who have actually become more productive (Silicon Valley, for example).
Most economists seem to think that money makes the economy function. Money allows the economy to function smoothly, of course, since a pure barter economy would be impractical. At best proper money management can help an economy function at its optimal level, but it can't actually increase production. Increased production can only come from people producing more.
But all else being equal, a society with more and more elderly people is not going to be producing more. All else being equal, a society with less-and-less STEM graduates is not going to produce more; and one with more-and-more people with lower innate human capital is going to produce less. And of course a society that increases its production of non-durable goods and services at the expense of tradable goods is not going to be producing more.
Despite the deep recession we just experienced, we have yet to fully pay the piper. The government seems to have finally given up on any serious efforts to prop-up the housing market, but the big banks have yet to realize their losses. Meanwhile, horrific deficits loom over us like dark storm clouds. We have not had sustained growth in excess of 3% since the 90's, so we can't literally grow ourselves out of these deficits. Our only recourse will be to inflate our way out.
Somehow or other we - as a society - need to figure out how we're going to pay the piper. The most just and constructive approach would reward those who have avoided leverage and punish those who have exploited leverage. But the Krugman approach - inflating our way out of debt = would of course do the exact opposite - reward the debtors and rape the savers. But it's even more critical to be fair at the institutional level. We cannot allow high-leverage banking to be a lucrative profession in relation to actual productive enterprises. We'll never approach the 4-5% per annum growth levels of the post-war years again, but we can get ourselves back in a respectable, true 2-4% level. But it won't be easy. More on that later.