And if Bob Wenzel agrees, it's a near certainty.
Bob Murphy first quotes Krugman's Japan paper (motivated by what he read of Scott's - brought to his attention by Wenzel) and then writes his own thoughts:
"The point here is that the end of the Depression – which is the usual, indeed perhaps the sole, motivating example for the view that a one-time fiscal stimulus can produce sustained recovery, does not actually appear to fit the story line too well; much though by no means all of the recovery from that particular liquidity trap seems to have depended on inflation expectations that made real interest rates substantially negative.Does everyone see the absolute stunning beauty here? Christmas is early this year. Back in 1998, Krugman referred to a “Krugman solution” as being: You get your economy out of a liquidity trap by relying exclusively on monetary policy, not at all on fiscal policy."
If temporary fiscal stimulus does not jolt the economy out of its doldrums on a sustained basis, however, then a recovery strategy based on fiscal expansion would have to continue the stimulus over an extended period of time. The question then becomes how much stimulus is needed, for how long – and whether the consequences of that stimulus for government debt are acceptable. …
The political point is that Japan – like, we might note, the United States during the New Deal – appears to have great difficulty working up its political nerve for a fiscal package anywhere close to what would be required to close the output gap. Exactly why is an interesting question, beyond this paper’s scope.
Does this mean that fiscal policy should be ignored as part of the policy mix? Surely not. On the general Brainard principle – when uncertain about the right model, throw a bit of everything at the problem – one would want to apply fiscal stimulus. (Even I wouldn’t trust myself enough to go for a purely “Krugman” solution). However, it seems unlikely that a mainly fiscal solution will be enough. [Bold added.]
[Slightly amended - I lifted a lot of this from a comment on Bob's blog. Bob is more savvy about the Japan paper than the guy I was responding to, so I'm changing this a little. For my original response click the link and find the comment. What Bob misses is that he seems to think Krugman in 1998 was substantially different than Krugman today] Some people think the Japan paper was about how Japan ought to do a lot of fiscal policy because monetary policy wouldn't work. The Japan paper actually said that the solution to the liquidity trap is monetary policy that credibly commits to irresponsibility. The point was only that traditional monetary policy, working through Taylor-rule type interest rate channels - would not work at the zero lower bound. You needed to act on expectations.
That was the headline message. That was what the paper was so famous for saying. The last time anyone talked about a liquidity trap there were no New Keynesians around. Old Keynesians cared about expectations of course, but they never really did a very good job modeling it formally. Nobody did a good job modeling it formally until the rational expectations revolution followed up on the inroads made by Phelps and Friedman w.r.t. expectations and the Phillips Curve. So the Old Keynesians always used to highlight how monetary policy would not work in a liquidity trap.
Krugman, a New Keynesian, sees a liquidity trap in Japan and is able to think about the role of expectations in more formal terms, and says “look we always thought monetary policy was useless in these cases but it’s really not”.
His solution was the credible commitment to irresponsibility.
Liquidity traps are bad news. Fiscal policy can help monetary policy out. You can get this result in a lot of models. Krugman said that too.
As far as I know this was Krugman’s view in 1998 and this is Krugman’s view today. This is only "devastating" if you think Krugman in 1998 was not advocating fiscal policy (he was, because traditional monetary policy was off the table and unconventional monetary policy relied on a commitment to doing things the central bank had a reputation for not doing) or if you really live under a rock and think that the Japan paper was about how monetary policy doesn't work in a liquidity trap.
To be blunt, if you thought the Japan paper was principally about how fiscal policy is the way you fight liquidity traps, you don't understand the Japan paper.