Krugman uses the title "Death of a Fairy Tale" in his NY Times blog article. Krugman calls the austerity policy employed in many European countries a destructive economic doctrine.
Krugman claims that economic textbooks suggest that in severely depressed economies governments should spend more to take the place of falling demand rather than cutting spending to try and balance budgets. No doubt Keynesian liberal oriented textbooks suggest this but not all economists would go along.
The "austerians" as Krugman calls them argue that austerity measures restore confidence to investors and hence the economy will grow rather than continue in recession. As Krugman puts it the confidence fairy will come and reward policy makers for their virtue.
The results of austerity policies throughout the European countries where it has been employed are evident. Even more contraction of GDP, increasing unemployment, social unrest, and little or no sign of recovery. Krugman seems genuinely puzzled by the continuation of austerity policies in the face of empirical evidence that they do not work. Krugman suggests that perhaps the cause is an irrational fear of increased debt levels. But there are good reasons for austerity policies from a capitalist viewpoint that Krugman's analysis ignores.
Austerity policies have the effect of lowering wage demands and weakening unions. This means that labor costs will go down and this is a positive for capital and investors in the longer run. Austerity policies shrink the social safety net and pension payments and this can lead to lower taxation rates since the govenrment requires less revenue. Finally as part of austerity measures state assets and services are sold off providing investment opportunities as the assets often are sold at fire sale prices. The money is used to pay off debt.
While in the short run the austerity policies may reduce growth, policy makers are beginning to recognize this as a problem. The response will no doubt be to provide even more incentives for business to begin investing in countries where austerity policies reign but to keep most of the austerity policies in place. In the long run they are good for investor confidence since they lead to lower labor costs, provide investment opportunities, and reduce government services that do not directly help business. A temporary decrease in GDP may be a small price to pay for policies that do help capital in the longer term. For more see this article.