Should-Read: I think Skidelsky gets it closer to right here than Krugman did in the piece Skidelsky is critiquing: Robert Skidelsky: How Economics Survived the Economic Crisis: "Unlike the Great Depression of the 1930s, which produced Keynesian economics, and the stagflation of the 1970s, which gave rise to Milton Friedman's monetarism...
...the Great Recession has elicited no such response from the economics profession. Why?... There are serious problems with Krugman’s narrative.... Krugman’s... response is that the New Keynesians... [had] a failure not of theory, but of “data collection.” They had “overlooked” crucial institutional changes in the financial system.... Faced with the crisis itself, the New Keynesians had risen to the challenge. They dusted off their old sticky-price models from the 1950s and 1960s, which told them... budget deficits would not drive up near-zero interest rates... increases in the monetary base would not lead to high inflation... and... there would be a positive... multiplier... from changes in government spending and taxation.... [But] the success of New Keynesian policy had the ironic effect of allowing “the more inflexible members of our profession [the New Classicals from Chicago] to ignore events in a way they couldn’t in past episodes.” So neither school–sect might be the better word–was challenged to re-think first principles.
This clever history of pre- and post-crash economics leaves key questions unanswered.... Krugman admits to a gap in “evidence collection.” But the choice of evidence is theory-driven. In my view, New Keynesian economists turned a blind eye to instabilities building up in the banking system, because their models told them that financial institutions could accurately price risk.... Krugman fails to explain why the Keynesian policies vindicated in 2008-2009 were so rapidly reversed and replaced by fiscal austerity.... The answer I would give is that... Keynes was briefly exhumed for six months in 2008-2009... for political, not intellectual, reasons.... Krugman comes close to acknowledging this: New Keynesians, he writes, “start with rational behavior and market equilibrium as a baseline, and try to get economic dysfunction by tweaking that baseline at the edges.”... The problem for New Keynesian macroeconomists is that they fail to acknowledge radical uncertainty in their models, leaving them without any theory of what to do in good times in order to avoid the bad times.... Without acknowledgement of uncertainty, saltwater economics is bound to collapse into its freshwater counterpart.... So Krugman’s argument, while provocative, is certainly not conclusive. Macroeconomics still needs to come up with a big new idea...