I am not certain that the AD story pushed by Krugman & others is absolutely wrong, but I'm definitely skeptical. There are alternative views out there from mainstream respected economists. Disagreeing with Paul Krugman does not automatically qualify one as mentally unfit, though the reactions of his supporters to criticism of Professor Krugman may, at times, make it seem like that is the case.
Here's Professor Raghu Rajan:
Some commentators argue that demand is too low now, that we need a negative real interest rate. Another way of saying this, though, is that the profitability of investment is really low, and households’ desire to save is really high. A strongly negative real interest rate “works” by subsidizing investment (when you borrow to invest, savers pay you for taking their money) and by encouraging consumption and penalizing savings (you have to pay others for the pleasure for borrowing from you)....Go read the whole thing for a discussion of why business is hesitant to invest and consumers are reluctant to spend. It includes a sobering ending last two paragraphs concerning the possibility that low rates can form the basis for another asset price bubble.
So why are so many Americans unemployed ? How do we return the economy to sustained growth? Are strongly negative short term real rates part of the cure? Perhaps we should recognize that the recoveries from the last two recessions (1991 and 2001) have been jobless, despite substantial monetary stimulus. Indeed, the negative real rates during the recovery in 2002-2004 did not prompt substantially more corporate hiring, but created a debt-fueled real estate boom and consumption orgy that we have yet to recover from. The rates were not low enough to prompt corporations to invest (they had just been through an investment boom), but low enough to trigger off a housing boom and a consumption boom. The remedy this time around cannot lie in creating unsustainable growth again.
Why have recoveries been so slow in creating jobs? I don’t think we really
know. But given our limited knowledge and our recent experience, I think we have to be more cautious about advocating negative real rates as a cure-all.
As with so much in economics, this is far from a settled question.