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Nobel Laureate Paul Krugman on the Economy

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Paul Krugman
Princeton University Professor and New York Times Columnist
Monday, December 15, 2008; 1:00 PM

In 1999, Princeton economics professor Paul Krugman wrote a book with the now-prescient title The Return of Depression Economics. The book has just been re-released in a revised and updated edition, which examines the roots of the crisis now affecting the global economy. Earlier this year, Krugman was awarded the Nobel Prize in Economics for his work on international trade theory. He is also the author of a twice-weekly column and daily blog for The New York Times.

Krugman was online Monday, December 15 to discuss his views on the ongoing financial crisis, and the response from government, Wall Street, Detroit and elsewhere.

A transcript follows.

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Paul Krugman: Hi everyone. This is Paul Krugman. I'd like to say thanks to the Post for inviting me here.

A few words about my new book, The Return of Depression Economics and the Crisis of 2008.

This is a heavily revised new edition of The Return of Depression Economics, originally published 9 years ago. When I wrote the original version, I had Asia on my mind: I looked at the crisis that swept Southeast Asia, and at Japan's monetary trap, and argued that these were omens - that similar things could happen to us.

Now they have. The world economy is in a nosedive, and understanding what I call "depression economics" - the weird world you get into when even a zero interest rate isn't low enough, and a messed-up financial system is dragging down the real economy - is essential if we're going to avoid the worst.

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North Carolina: Why do you say that just one American automobile industry bankruptcy will bring down the entire American automobile industry?

Paul Krugman: The answer is that the Big 3 rely on a lot of the same suppliers. If, say, GM goes bust, that will doom a lot of the companies that produce parts for Ford and Chrysler; that will bring the whole traditional industry down.

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Ellicott City, Md.: Where do you think we would be today if the bank bailout package hadn't passed in September? Was it worth the haste?

Paul Krugman: I think that without the bank bailout the whole system would have collapsed. In the first couple of weeks after Lehman went down, nothing was moving in the credit markets, and it looked as if a series of dominoes might fall. Even though things are terrible now, they would probably have been a lot worse without the bailout.

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Watertown, Conn.: Do you agree that the Community Reinvestment Act (CRA) is the cornerstone of subprime lending, the root cause of financial meltdown?

Paul Krugman: No, and I'm glad someone brought that up. CRA has been in existence since 1977; plus, it only applies to depository institutions (regular banks). Meanwhile, we had a subprime bubble that mostly took place after 2002, with most of the loans made by institutions that weren't subject to the CRA.

That's why everyone who's looked at this honestly says that the Community Reinvestment Act had nothing to do with the crisis.

The attempt to blame it all on the CRA is just an attempt at blame-shifting -- an attempt to make liberals and nonwhite people the villains of a story that is actually about runaway financial institutions and the free-market ideologues who refused to regulate them.

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Chicago, Illinois: Does the world need a new Keynes? Any nominations?

Paul Krugman: Actually, right now we need the old Keynes. His work is a very good guide to our current predicament. The German finance minister calls people like me "crass Keynesians", but I wear the label with pride!

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D.C.: What did Japan do wrong in the 90's and how can we avoid the same fate?

Paul Krugman: To be honest, I think US economists are feeling a bit more respect for the Japanese, or at least sympathy for their plight. Avoiding a Japan-type experience is proving harder than most economists thought -- even economists like Ben Bernanke, who'd worked hard on analyzing Japan.

But the big message I take from Japan's experience is the folly of excessive caution. If you're half-hearted about taking on the slump -- if you wait to cut interest rates, nickel-and-dime your fiscal stimulus, penny-pinch on your bank bailouts -- then by the time you realize more is needed, deflation has set in, and it's really hard to get out of the trap.

So you want to be really, really aggressive on policy early on.

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Honeydew, California: Will you please explain how or if we can adapt Depression era lessons to the current crisis?

Paul Krugman: The Depression offers a lot of more or less direct lessons. For example, the Big Mistake of 1937: FDR let himself be persuaded that he should try to balance the budget even though the economy was still depressed; the result was a severe recession in 1938. What the Depression teaches us is that when the economy is so depressed that even a zero interest rate isn't low enough, you have to put conventional notions of prudence and sound policy aside. Now as then, we've got an economy that needs temporary life-support from the feds; not where we want to be, but where we are.

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Richmond, Va.: I am interested in reading some Keynes, several years ago I took some economics courses and recall the professor saying that Keynes had been reconciled to the history books and was not really relevant in our current world. Where should I start?

Paul Krugman: Read "The Great Slump of 1930" -- available online for free, via Gutenberg Project. It will give you a sense of how Keynes thought. Also his open letter to FDR in 1933.

If you're feeling tough enough, you might also try the first few chapters of the General Theory; they summarize the main argument, and are easier going than the later chapters (though that's not saying much).

And your teacher was quite wrong: Keynes is utterly relevant to the modern world. Read The Great Slump and tell me that this doesn't sound like a description of current events.

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Washington D.C.: Are you smarter than Larry Summers?

Paul Krugman: No -- Larry is incredibly smart. Ask him, he'll tell you. Seriously, people are different. I can't do a lot of things Larry can, he probably can't do some things I can. I have huge respect for his intellect.

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washingtonpost.com: The Great Slump of 1930 (Project Gutenberg)

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Tampa, Fla.: Are you concerned that Obama's economic advisers have so many ties to Wall Street? Can these people regulate the businesses they seem to be so much a part of? I'm thinking of Robert Rubin and his many proteges here.

Paul Krugman: I am a bit worried, although I don't think we're looking at raw corruption here. The problem might instead be what one economist (Willem Buiter) called "cognitive regulatory capture" -- hang out with Wall Street types, and you tend to see the world their way.

That said, the top people coming in are intellectually flexible and very smart; and it's worth pointing out that Tim Geithner has been a public servant all his life, he's never gone through the revolving door. And there's a lot to be said for having people coming in who know where the bodies are buried. We have to move fast; there's no time for on-the-job learning.

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Arlington, Va.: Good time to buy a house or bad time?

Paul Krugman: Not good. If you look at simple measures like the ratio of prices to rents or incomes, houses are STILL overvalued by historical standards. Add in the likelihood that prices will overshoot on the down side, and I don't think anyone is going to be making money on houses bought now.

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Albany, N.Y.: Do you think that we'll see it come out that there were many Madoff-type Ponzi schemes running? Do you agree with the assessment that a lot of what was driving the real estate and mortgage-backed markets was, in effect, a Ponzi scheme?

Paul Krugman: I hope that the extreme nature of the Madoff thing was an exception; most hedge funds place their funds with independent brokers, so they can't get away with just pretending to have assets the way Madoff did. But I wouldn't rule out the possibility that other huge frauds will surface.

But on the larger question: yes, the whole real-estate finance thing was a Ponzi scheme, though not necessarily a deliberate one. Robert Shiller pointed out a decade ago that any speculative bubble is in effect a natural Ponzi scheme, in which earlier investors are paid off by later investors, and everything looks great until you run out of suckers. The housing and finance bubbles created the illusion of massive wealth creation, then turned in a couple of giant rotten pumpkins.

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Washington, D.C.: Did it raise an eyebrow that they waited until after the election to declare we had been in a recession for over a year? The group of economists that label when recessions start - it's headed by Martin Feldstein, right? Is it balanced among partisans?

Paul Krugman: It's a balanced panel; for example, my classmate Jeff Frankel is pretty clearly a Democrat. As for the timing: I won't say categorically that the election didn't play a role, at least subconsciously, but the truth is that they really couldn't declare a recession until 3rd quarter GDP was in and there had been a couple of really bad payroll numbers. The NBER panel is supposed to interpret history, not call turning points in real time. They're supposed to be cautious.

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Pittsburgh: Your column is a must-read for me every week. Thanks for taking questions today. I used to manage a small brokerage firm for a very large bank. Over the last several years I was very concerned that job growth was really lousy and we were running up all this debt. What I didn't see was how the housing crises would play out. I have been combing through the financial press and have come to realize that "The Economist" and others had a pretty good handle on what was going on over a year and a half ago. What would you recommend reading on a daily/weekly basis from here on out?

Paul Krugman: You should of course read The New York Times religiously -- actually, the business reporting is very good. I also find that the Financial Times is very helpful, with a different slant owing to its London base. Other than that, I think it's worth skimming the economic/financial blogs -- Mark Thoma's Economist's View, Calculated Risk are favorites of mine.

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Evanston, Illinois: What are the prospects for some real progressive economists getting in the administration? I'm thinking James Galbraith, Joe Stiglitz, Bob Kuttner, yourself, Robert Pollin, Dean Baker, Michael Hudson etc. I guess Jared Bernstein is one.

Paul Krugman: I don't want a job in the administration; I think I'm more effective carping from the sidelines. I suspect the same goes for Joe Stiglitz. But I think it would be great to have Galbraith, Kuttner, Larry Mishel, or some of the others on your list playing some role, if only to provide a diversity of views. I'm eager to see who will be on that Volcker panel, but there are other places progressives could play a useful role.

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Washington, D.C.: Keynesian policies were a part of the solution, but most people agree that the Depression truly ended when America entered World War II and began war production spending. Do you have a global war scenario that we should follow after implementing a decade of extraordinary Keynesian policies?

Paul Krugman: There's nothing magic about spending on tanks and bombs rather than roads and bridges. The reason World War II worked more effectively than the WPA was that it was *bigger*: the caution that had limited previous stimulus efforts went away in the face of total war.

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Yonkers, N.Y.: Barney Frank said on 60 Minutes last night that the economic crisis will be past in about a year or so -- was he trying to calm fears, or do you think he really believes this?

Paul Krugman: We *could* be past the worst in a year, mainly because with a year's lead time we can do a lot to stimulate the economy -- anything less than that and we're constrained by the limited supply of "shovel-ready" projects.

But there's nothing automatic about it. If policy is weak and confused, this crisis could go on for years and years.

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Va.: Hello. Most right-wing economists are at AEI, Heritage and other think tanks. Is there an intellectual diversity dearth on campus? How can we as students learn about other economic theories?

Paul Krugman: Just a word about this: we have conservative economists here at Princeton. Harvey Rosen was on Bush's Council of Economic Advisers! And think about the conservatives elsewhere, like Robert Barro at Harvard.

What we don't have at universities are zealots like the people at Heritage, who offer the same canned answers whatever the question.

One more thing: at places like Princeton or MIT, our students learn alternative points of view; not so much at more uniformly conservative schools. One test I like to point out is that our students, if asked, "what would an equilibrium business cycle guy say about this?" can answer -- they know how the other side thinks. Whereas at various places I won't name, students have no idea how a Princeton economist thinks.

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Princeton, N.J.: While you are debunking conservative myths (CRA), how about the one that the whole housing crisis was due to corruption at Fannie and Freddie?

Paul Krugman: OK, glad someone asked that. The thing is that there *was* corruption at Fannie and Freddie, which makes them hard to defend. But the crucial point is that because Fannie and Freddie were under scrutiny over accounting scandals, their share of mortgages outstanding was *falling* during the height of the housing bubble. This in turn means that private lenders were responsible for the bulk of the bad lending. You have to go through huge intellectual contortions to blame institutions for bad loans they didn't make and didn't securitize. But of course if you believe as a matter of faith that government is the root of all evil ...

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Amherst, Mass.: You mentioned in a news program that eastern Europe was the epicenter of the financial crisis. Could you explain, and is the Czech Republic included in that assessment?

Paul Krugman: You have a number of countries that attracted large inflows of capital, taking out big loans in euros. Now the capital inflow has gone into reverse, and they're in deep trouble -- trouble very similar to that of Indonesia in 1998 or Argentina in 2002. The list of problem countries includes Hungary, Ukraine, Romania, Latvia, and more. I haven't seen much about the Czech Republic, so I can't really comment.

btw, all this spills back to the more developed European economies. The mess in eastern Europe is one reason the German economy is heading into a severe recession (someone tell the Chancellor).

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Philadelphia, Pa.: Some monetarists such as Niall Ferguson of Harvard University state now is the time to increase the money supply. Do you agree the money supply should be increased? Where do you agree or disagree with such monetarists?

Paul Krugman: At this point I don't even know what the money supply means. I mean, there's an official definition -- two, actually (M1 and M2) -- but there are a lot of other assets that are sort of money-like. Funds invested in money-market funds; funds invested in auction-rate securities before they went belly-up; anything that looked like cash available on short notice.

So I'm all for a vigorous monetary expansion -- which Ben Bernanke is trying to accomplish. But I don't think there's any magic in making M-whatever bigger according to the official statistics.

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Anonymous: Do you read the economics blog "Calculated Risk"? If so, do you comment and under what alias?

Paul Krugman: Yes, no. I read; if I have something to say, I say it in the Times or on my own blog.

Of course, I could be like one of those guys who uses an alias to write glowing Amazon reviews of his own books ...

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Omaha, Neb.: What is the one thing that you would advise the Bush Administration to do on the economy before they leave?

Paul Krugman: Give the auto companies enough credit to survive until January 20th, then get out of the way.

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Anonymous: Hi. Any concern about FOX/Murdoch owning the WSJ as far as accurate, unbiased financial reporting?

Paul Krugman: I have a lot of concerns; News Corp really does terrible things elsewhere. I have to say, however, that so far the WSJ looks the way it always did: good straight news reporting, an editorial page that seems to live on some other planet.

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Paul Krugman: OK, folks. I'm really sorry to call an end to a great discussion, but other duties call. Good luck to all of us in this scary world.

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