Discussing Krugman's racy PIMCO quote, Scott Sumner says:

As everyone knows by now the once kooky and discredited Austrian business cycle model has now become conventional wisdom. Easy money creates bubbles, which inevitably cause depressions when they pop. It’s Greenspan’s fault. Paul and I are still not on board the Vienna express, but we are in an awkward position. (Thank God I didn’t have a blog in 2002!)

So the above is refreshingly funny and humble, but then Sumner goes on to say:

Here’s what I think is a defensible view of what Paul might have meant...The words are mine [Scott Sumner's--RPM], not Paul’s:

“Business investment is tanking. A sharp fall in overall investment can often lead to a depression. The Fed should reduce interest rates...Because tech is so overbuilt, the lower interest rates may not be enough to bring business investment back to normal levels, instead other types of investment and consumer durables will have to pick up the slack. We can expect the housing sector to expand if rates are cut sharply....In the classical model we would then be moving along the investment PPF from less business investment to more housing investment, instead of moving far inside the PPF (as in the 1930s) with less overall investment as the economy tanks. Let’s hope bankers lend money to people who are likely to repay their loans, so that the bankers do not lose hundreds of billions of dollars, and their jobs. Monetary policy has no choice but to proceed on the assumption that we should stabilize the overall macroeconomy, and let the private sector decide where to allocate resources.”

Oh Scott Scott Scott. The issue about the PPF is tricky; as Garrison's PowerPoint [.ppt] make clear, the problem of an unsustainable boom is that the low interest rates lead to greater (apparent) investment and consumption. That is physically impossible, which Garrison denotes by showing the economy moving beyond the (sustainable) PPF.

But the real problem is that part I put in bold. This is the primary weakness in all Keynesian (and Chicagoan) demand-management prescriptions. What exactly does the interest rate do in a market economy, according to these economists? Scott's statement is like saying, "I'm not saying the government should stimulate the health care sector, I'm just saying it should subsidize stethoscopes."

In case I'm being too cute: What I'm saying is that the interest rate is a price that allocates investment among projects of different length. It's not merely a lever for "more investment or less?" To lower interest rates, in the hope of spurring total spending while ignoring the distortions among choice of investment projects, would be akin to raising taxes on labor and not realizing this would affect hair salons more than oil rigs.