I think Paul Krugman gets this one right:
Aggregate Supply and Depression Economics: "Robert Waldmann follows up on the question of who got what wrong in the late 1990s analysis of Japan’s liquidity trap...:
...As he says, the extremely stripped-down nature of the model I used may have led some readers — like, surprisingly, Brad DeLong — to suppose that I had forgotten about the supply side. Actually, though, I still don’t really understand the confusion — I explicitly began with a flexible-price model, then considered the effects of temporarily fixed prices, so how could that have been unclear [to people like Brad DeLong]?
Be that as it may, it’s quite ironic given recent events that some critics of the old paper warned that higher expected inflation might get built into wage and price setting — because that’s what you want to happen. It’s a feature, not a bug.
Indeed, the biggest problem with Abenomics — which is the closest thing we’ve seen yet to an attempt to bootstrap an economy out of the liquidity trap by promising higher inflation — is precisely that so far inflation expectations, while they have moved asset markets, haven’t translated into sufficiently higher inflation in the real economy. The idea that inflation promises might go directly into prices is a hope, not a worry.
So why did smart people get so confused by all this (and some still are)? Partly, I think, because liquidity trap economics — depression economics — is deeply counterintuitive to many people, including economists. I tried to make it more intuitive with an extremely simple model, but evidently that didn’t work for everyone.
?Beyond that, in the late 1990s, and even now to some extent, we were suffering from the tyranny of the 1970s, with too many people seeing stagflation around every corner. In fact, it’s still happening now, despite the reality that the post-2008 crisis was far worse for the world’s major economies than the stagflation of the 1970s ever was.
Again, I tried to break through that obsession, with some modeling that I’m still very proud of, and with a book that I think looks very good in retrospect. But sometimes you can’t change preconceptions, no matter how clearly and simply you write. Sad!