The Economist is hosting a lively online debate on the question of whether "we are all Keynesians now." It turns out both sides of the debate--Berkeley's Brad DeLong and Chicago's Luigi Zingales agree that we're not. But that's about all they agree on. Here's DeLong:
The argument that Messrs Fama, Prescott, Cochrane, Barro, Poole and company [all rejectionists] are making is what economists call Say's law. It is the claim that decisions to increase spending—whether they come from the government or anybody else—cannot spur the economy and raise employment and production because demand must be created by supply. If the government spends, somebody else must cut back on their spending.
Anyone who uses his or her eyes can determine that Say's law is in general false. Recall 2003-06, when capital inflows from Asia, easy money provided by the Federal Reserve and promises that financial engineering would cheaply diversify risk spurred homebuilders to spend money building houses. The American unemployment rate fell from 6.0% to 4.8%. Recall 1996-2000, when the assembled investors of America discovered the internet and in response businesses spent money like water on computers and telephones. The American unemployment rate fell 5.6% to 4.3%. In general, spending works to spur the economy, and the government's money when spent is as good as anybody else's.
I am not disputing the idea that some government intervention can alleviate the current economic conditions, I am disputing that a Keynesian economic policy can do it. With a current-account deficit that in 2008 was $614 billion, a budget deficit that was $455 billion and military expenditures of $731 billion, it is hard to argue that the government is not stimulating demand sufficiently. The current crisis is not a demand crisis, it is a trust crisis. Bad corporate governance coupled with bad government policies has destroyed the financial sector, scaring investors and freezing lending. It is as if a nuclear bomb had destroyed all roads in America and we claimed that to alleviate the economic impact of such an event we should invest in banks. It is possible that eventually the effect will trickle down. But if the problem is the roads, you want to rebuild roads, not subsidise the financial sector.