Before dealing directly with his accusations about the ATBC, I will note that both David Gordon and Robert Murphy do credible jobs in debunking Krugman's misrepresentations. I will add briefly to what they already have written.
...one more thing struck me: at least some members of the FOMC have bought into the hangover theory — the modern version of liquidationism in which mass unemployment is somehow necessary in the aftermath of a burst bubble....This is an important point, because while Austrians are adamant that malinvested resources and capital that were created or advanced during the boom are NOT sustainable during the crisis and the subsequent bust. (Krugman, it should be noted, insists on saying that Austrians, such as Nobel-Prize Laureate F.A. Hayek, push an "overinvestment" theory when, in fact, the Austrians have dealt with that very term and have said it is not an appropriate one in the ATBC. In other words, even though Austrians address that very word, Krugman still pretends as though they have not done so.)
Furthermore, Austrians, unlike Keynesians, who believe that factors of production generally are homogeneous and are equally affected by new injections of spending, look carefully at the issues of the factors, for what is where the result of the downturn are concentrated. Furthermore, NO Austrian calls for some sort of "general liquidation" of the economy. Instead, Austrians hold that those investments in capital and other factors that no longer are sustainable should be liquidated or transferred to other uses for which there clearly is consumer demand. This is a far cry from Krugman's point.
I know of NO Austrian who claims that "mass unemployment is somehow necessary in the aftermath of a burst bubble," none. Austrians say that if there is mass unemployment (and especially if that unemployment is chronic) we can look to government intervention as the reason. Rothbard, in America's Great Depression, writes:
If government wishes to see a depression ended as quickly as possible, and the economy returned to normal prosperity, what course should it adopt? The first and clearest injunction is: don't interfere with the market's adjustment process. The more the government intervenes to delay the market's adjustment, the longer and more grueling the depression will be, and the more difficult will be the road to complete recovery. Government hampering aggravates and perpetuates the depression. Yet, government depression policy has always (and would have even more today) aggravated the very evils it has loudly tried to cure. If, in fact, we list logically the various ways that government could hamper market adjustment, we will find that we have precisely listed the favorite "anti-depression" arsenal of government policy. (Emphasis mine)Rothbard then explains the policies that are most harmful:
1. Prevent or delay liquidation. Lend money to shaky businesses, call on banks to lend further, etc.Interestingly, ALL of these things listed above are precisely what Krugman claims will END the downturn. Yet, we have seen government do these things in spades, yet the economy continues to tank. Rothbard clearly notes that mass unemployment, and especially mass unemployment over a long period of time, is NOT necessary, but generally occurs because of government intervention, not in spite of it.
2. Inflate further. Further inflation blocks the necessary fall in prices, thus delaying adjustment and prolonging depression. Further credit expansion creates more malinvestments, which, in their turn, will have to be liquidated in some later depression. A government "easy money" policy prevents the market's return to the necessary higher interest rates.
3. Keep wage rates up. Artificial maintenance of wage rates in a depression insures permanent mass unemployment. Furthermore, in a deflation, when prices are falling, keeping the same rate of money wages means that real wage rates have been pushed higher. In the face of falling business demand, this greatly aggravates the unemployment problem.
4. Keep prices up. Keeping prices above their free-market levels will create unsalable surpluses, and prevent a return to prosperity.
5. Stimulate consumption and discourage saving. We have seen that more saving and less consumption would speed recovery; more consumption and less saving aggravate the shortage of saved-capital even further. Government can encourage consumption by "food stamp plans" and relief payments. It can discourage savings and investment by higher taxes, particularly on the wealthy and on corporations and estates. As a matter of fact, any increase of taxes and government spending will discourage saving and investment and stimulate consumption, since government spending is all consumption. Some of the private funds would have been saved and invested; all of the government funds are consumed. Any increase in the relative size of government in the economy, therefore, shifts the societal consumption-investment ratio in favor of consumption, and prolongs the depression.
6. Subsidize unemployment. Any subsidization of unemployment (via unemployment "insurance," relief, etc.) will prolong unemployment indefinitely, and delay the shift of workers to the fields where jobs are available.
So what does Krugman do? He claims that the REAL problem is that government did not spend enough, regulate enough, tax enough, jack up wages past marginal productivity levels, and subsidize enough unproductive industries (i.e. "green" jobs). And when the economy continues to tank, he creates a caricature of the only business cycle theory that accurately explains what is happening, and then builds a series of falsehoods from there. Just another day at the office for Paul Krugman.