From my favorite Krugman blog post of all time:
I’ve already pointed out the problems, both logical and empirical, with the claim that workers are unemployed because they have zero marginal product. But there are many more problems with the notion of a recession as a supply shock.
A short sample: If inflation is a case of too much money chasing too few goods, why aren’t slumps associated with accelerating rather than decelerating inflation, as the supply of goods falls? Why is there such a strong correlation between nominal and real GDP? Why is there overwhelming evidence that when central banks decide to slow the economy, the economy does indeed slow? And on and on.
I think I understand all of his objections, but the two I’ve put in bold above, I’m not 100% sure I get what he is saying. So let me paraphrase what I take to be his argument, and then the Keynesian sympathizers in the crowd can either confirm or deny my interpretation:
(1) Austrians think the boom and recession are “real” phenomena; it’s not about spending or money.
(2) This is what the RBC people say too; they view recessions as a supply shock.
(3) Therefore the Austrians view recessions as a supply shock.
(4) If recessions were purely “real” phenomena, then we wouldn’t see nominal GDP fall when real GDP does. A recession would correspond to a drop in real GDP, of course, but it would be entirely possible for NGDP to keep rising at the normal rate, and for price inflation to make up the gap. But in reality, NGDP collapses when real GDP does, and then during the recovery, it’s not simply that price inflation falls (so real GDP catches up to NGDP) but rather, both real GDP and NGDP rise together. A purely “real” story has no explanation for this, so it’s more fruitful to think that the changes in NGDP are pulling down, or pulling up, real GDP with them.
(5) As a specific example of this point, central banks should have no ability to influence the “real” economy (and hence real GDP) if recessions were actually all about supply-side shocks. It doesn’t affect how many tractors there are, or the skills of computer programmers, if the Fed decides to slow the growth in the monetary base. But clearly, the research shows that monetary policy has real effects. Unless your model incorporates a transmission mechanism from money to the real economy, you can’t possibly explain the recessions we have lived through in modern times.
Is this about right?