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Diplomacy in Action

The Return of Depression Economics?

FPC Briefing
Paul Krugman
Professor of Economics and International Affairs, Princeton U.
Foreign Press Center
New York, New York
April 13, 2009

Date: 04/13/2009 Location: New York, NY Description: Paul Krugman, Professor of Economics and International Affairs, Woodrow Wilson School, Princeton University New York Times columnist recipient of the 2008 Nobel Prize in Economics at the NYFPC briefing on "The Return of Depression Economics?" State Dept Photo
2:00 p.m., EDT
MODERATOR: All right. Good afternoon, everyone. Thank you very much for coming. Welcome to the New York Foreign Press Center. We are very excited about our briefing this afternoon. I want to just plug two other briefings before we can start today. We have another briefing tomorrow at 2 o’clock, a digital videoconference with Special Inspector on Iraq Reconstruction at 2 o’clock here. And at 3 o’clock, we have Dr. Ben Steil from the Council on Foreign Relations talking about money, markets and sovereignty.

But today, while you are all here, is for Professor Paul Krugman, Professor of Economics and International Affairs at Princeton University’s Woodrow Wilson School, a New York Times columnist and the recipient of the 2008 Nobel Prize in Economics. His most recent book, The Return of Depression Economics and The Crisis of 2008, is why he is coming here today. So we will – I’ll let him talk about that and then he will take questions afterwards.

Thank you all for coming and with that, Professor.

MR. KRUGMAN: I actually don’t have any prepared remarks. I don’t think I want to say more than – as you may have noticed, there’s an economic crisis. And it is, to some extent, the crisis that I’ve been worrying about as a possibility for more than a decade. This is actually a much revise – you know, The Return of Depression Economics in its original version was released in 1999, and so it’s massively updated. But qualitatively, the crisis we’re having is the same kind of thing I was worrying about in the late 1990s.

And I’m not sure what people are interested in. Judging from what I’ve been attempting to track in recent days, what people in the U.S. press corps are mostly interested in right now is dogs and pirates. But – so I think I should just throw this open for questions and see what people want to ask.

Oh, do we have – yeah, okay, we have a mike and everything.

MODERATOR: If you can please state your name and your organization.

QUESTION: Thank you. Thank you, Professor. John Zang (ph) with CTI-TV of Taiwan. I have two questions for you. I have come from Washington for you for this occasion. Sir, you are going to Taiwan next month for a visit. People in Taiwan, a lot of them, will be looking to you for advice and probably for suggestions as to how best to come out of this economic abyss.

Second question: The government of President Ma Ying-jeou is thinking about signing or negotiating a baby FTA in the name of economic cooperative framework agreement. But the opposition party has concerns about possible jeopardy to Taiwan’s sovereignty. What do you think about that? Thank you very much, sir, appreciate it.

MR. KRUGMAN: Okay. About the second, I don’t really – unless I know – knew something more about it. I mean, there is – you know, free trade agreements, all – all such agreements do involve some sacrifice of national autonomy. They – we do this all the time. Now it’s usually been a good thing. It sort of depends on what. I mean, there – so I can’t really – can’t really comment on that without knowing something more about it.

How to get out; I think there are actually two questions here. One is how do we mitigate this crisis and how do we prevent it from really turning into Great Depression 2.0. And I think we have a fairly clear understanding of the things you can do that limit the depth of it – very aggressive policies to free up financial markets, monetary expansion as far as it can go, widened menu of monetary policies and fiscal expansion. All of these things have invariably worked in the sense of when they’re applied, the economy does better than when they’re not.

And you know, we’re doing all of these things, but, you know, as everybody knows, I think not on a sufficient scale. But we’re – these are mitigation strategies and I think they apply to everybody. I mean, if – there’s no real question that they will help. The question of how do we actually end the thing is different, how do we actually get out the other end. And we don’t have a lot of role models for that. The Great Depression itself was ended by World War II, and we’re not quite sure even now why the Great – we know why World War II expanded the economy. We don’t know why the economy didn’t slide back into depression, though I have some ideas about that.

We – the nearest modern parallel is Japan’s lost decade. And that one ended – so far as it did – I mean, it’s now starting to look like the period of expansion may have been just an intermission – but that ended thanks to an export boom, which is not much help in a global slump unless we can find another planet to export to. So there’s a – I mean, my view is that we probably need major bank cleanup and probably sustained fiscal stimulus until the private sector can repair balance sheets enough to start spending again.

But you know, we’re feeling our way through this. And everybody’s going to have to – I guess my basic view is think of everything that might work and do all of it. So – okay.

QUESTION: I’m from Brazil and everybody there is wondering if the BRICs countries has a chance to grow in 2009 if the impact, the effect of the crisis in those countries will be less strong than in the developed world, and if those countries would have a voice in the international reorganization of the markets. What do you think?

MR. KRUGMAN: Okay. First of all, I think that BRICs is a terrible classification. I mean, it’s a really – I mean, there are four big emerging market economies, but they’re not at all, you know – of course, two commodity exporters, Russia and to a lesser extent, Brazil, and two, you know, manufacturing other stuff exporters, which is China and India, and then large differences even between those. So it’s not a good category.

What you can say is that commodity prices are holding up better than you might expect, actually, given this. I mean, it’s really kind of striking, actually. Even though they fall on a lot, it’s not as severe a hit as you might have expected given the depth of the slump, and particularly oil prices. The miracle here is actually that oil prices are still, in real terms, well above their levels at the beginning of the decade. So, you know, Russia has that advantage. They have a lot of other problems. They have that advantage.

Brazil – I haven’t had a chance to do an update on Brazil. My sense is that it’s not being hit quite as badly as some others. I don’t know what I think about China and India. You know, people are going to want me to tell them all about that. I’m still doing my homework on that because we’re trying to get together. But look, I mean, what we know is that decoupling has turned out to be completely not true, that it’s – this has been the most coupled, synchronized crisis since the 1930s.

But it does not look as if developing countries are being hit that much worse. This is a crisis where the real epicenters are in the developed countries, and while – aside from emerging Europe, which is where you had really terrible things happening, it’s not so severe elsewhere.

MODERATOR: We’ll take two more questions here in New York and then we’ll go to Washington.

MR. KRUGMAN: Oh dear, I didn’t realize we were – okay.

QUESTION: (Inaudible) in East Japan. I have two questions. Could you comment on the recent rally on the market? It didn’t really reflect the fundamental of the economy. And two things, one – a second thing, U.S. Government recently announced modification of the application of mark-to-market rule on security – so-called securitized international instrument. This is somewhat, to some certain extent, similar to what Japan has used as a prescription to overcome the financial crisis during the ‘90s. Could you also comment on that?

MR. KRUGMAN: Yeah. So the market – so I went back to sort of do an update. The famous old Paul Samuelson line was that the market had forecast nine of the last five recessions. So I went back to look at the market, at the S&P 500 distech eight, and as far as I can make out, the stock market has forecast six of the last one recoveries. It’s just not a reliable guide to what’s actually going to happen, right?

I think what the market is reacting to is partly the – we went through a period when all of the surprises in the economic news were negative. Things were always worse than people expected. We’ve gone to one where the surprises are mixed but some of them are positive, and that’s kind of made people feel better. But I don’t think it means very much. And you know, for what it’s worth, there are signs that the slump is decelerating, which is, you know, things are getting worse more slowly. There’s no sign of an actual turnaround in the data, so I think that people are getting way ahead of all of that.

The market – yeah, look, the mark-to-market is part of a broader picture. What I’m both inferring from policy and hearing from – you know, indirectly is that there really is – the idea really is now to buy some time, not – instead of let’s move in and do a thorough recognition of losses on the part of the financial system and let’s do whatever it takes to clean up the mess, the idea is that we’re going to buy some time, perk up the balances. Maybe the banks aren’t really in such bad shape. Maybe they can earn their way out. The line I’ve heard is, well, you know, if we had done mark-to-market in 1982, ’83 when we had the Latin American debt crisis, we would have shut down Citibank and probably several other money center banks. And we didn’t and that worked out okay, and so what – why not do this again.

So actually – and all of that is kind of like Japan. I mean, no I – one of my lines now is that we really owe the Japanese an apology. All of this berating from Western observers about how Japan delayed and they papered over their problems and they avoided decisive action – well, it turns out that faced with a similar situation, we’re doing exactly the same thing. So yeah, we – I don’t know if I put this in print yet, but yeah, I mean, it’s Timothy Geithner’s song. It really is, that we’ve gone to a – we’ve – I think we’ve just proved that it’s actually, you know, it’s not so easy and that you do drift.

One more thing on that: Actually, you know, given the current perspective, given the huge rise in unemployment that the United States is suffering, Japan’s lost decade looks pretty good actually right now. It’s – you know, we’re doing worse than Japan did.


MODERATOR: Sir, right here.

QUESTION: Tom Bronson (ph), Belgium (ph) Magazine (inaudible). Everybody blames the housing and financial bubble --

MODERATOR: Put your microphone closer.

QUESTION: Okay. Everybody blames the housing and financial bubble for the crisis. But without the world effect that they created, what could have carried the expansion of the world economy through the last decade?

And related to that, this growth was fueled by the creation of that. But with the stimulus program, are we not doing the same thing? Are we not re-flating the bubble?

MR. KRUGMAN: Okay. So actually, those are – let me make a note so I don’t lose the thread, which is so easy to do with this.

So about the bubble, the way I look at it is – no – just to say, if you want to go back to the history, we do forget how frightened, particularly in the United States, we were at the economic outlook in 2002 and early 2003. It was a persistently depressed economy. Officially, the recession had ended, but in terms of employment, things were still getting worse. There was a real perceived threat of deflation. And sure, the bubble came as – the beginnings of the housing bubble came as a rescue from that trap. The only problem, of course, is that when the bubble burst, we end up in a much worse version of the same problem. So on the whole, we would have been better to have done whatever was necessary then rather than later.

But I think the real question is where in a bubble-free world are we going to find the sources of demand? You know, and I’m not ready to become a – secular stagnation was the old phrase, the belief that we have persistently inadequate demand. But it is a little hard to think about where the demand is going to come from. You have a world with extremely high savings in China and a few other places. Where are the investments prepared to absorb those savings? I think that’s something we’re going to have to figure out. Probably persistently higher business investment, but how do we get to there is a real question.

The debt issue; I think the way to think about this – in a way, drop the distinction between public and private debt for a moment. Why are things so bad? And the answer is that what we’ve got is a situation in which we have synchronized rises and falls in debt. Everyone was trying to borrow more and buy more assets at the same time. That’s the bubble. And now we have a situation where everybody’s trying to deleverage and everybody’s trying to save more, which is the slump. And so we’re now caught in paradox of thrift territory, where everyone’s trying to save more and the result is to depress income, and we all end up actually poorer. We’re also in paradox of deleveraging, where everybody’s trying to sell assets and pay off debt, and the end result is that asset prices drop and balance sheets get worse.

And what you really want is some major actor to go in the opposite direction. You want some major actor to run up debt when everyone else is trying to reduce it, and some major actor to pay down debt when everyone else is going crazy. And that is the role of government spending. The problem is not just that people have ran up too debt – too much debt. The problem is that everybody ran up debt at the same time and then everybody’s trying to pay off debt at the same time. And that’s why we have the disaster.

So it’s not as simple as saying, well, debt was the problem and therefore, how can debt be the solution. It’s – what we need is someone to give us a chance to get through this without a severe slump to break the vicious circle where everyone is trying to save more all at the same time.

MODERATOR: We’re going to go ahead to Washington.

QUESTION: Good afternoon, (inaudible) Business Press online, Slovakia. My question is about the currency and about the different approach of Europe. Europe is not throwing so much money in stimulus packages like the U.S. And I would like to know if – do you see also a different outcome on the side of the currency? Dollar are weaker and the U.S. stronger in the long run, the depreciation of the dollar because of inflation? And do you think that U.S. is victimizing its currency and (inaudible) its economy, or (inaudible) have to do the same IQS (ph), and also much more money in the economy and stimulus packages like the U.S. is doing now?

MR. KRUGMAN: Okay. So I think on this, the United States is right and Europe is wrong. When you’re confronted with this kind of risk, you pull out all the stops. You do what you can do. And the – I don’t at all accept the idea that the U.S. is risking a lot of inflation down the road. It’s the – yes, there’s a big expansion of the Federal Reserve’s balance sheet, but that can be reversed quite quickly. And the Fed is itching to do that as soon as it can, so I don’t think it’s actually going to be inflationary. Deflation is the bigger threat.

The fiscal deficits are large, but if you take a long-term perspective, they’re not actually adding that much to the burden. We do have a long-term fiscal problem. An extra trillion dollars is actually not going to make that much difference to the size of that problem. The – and in terms of dollar versus euro, actually, my sense is that the euro’s prospects of becoming co-equal with the dollar as a world currency are actually going down, not up.

And the reason has nothing to do, really, with the policies of the Fed versus the policies of the ECB. The big issue has been the euro zone is an economy comparable in size to the dollar zone. The euro bond market is comparable to the dollar bond market. So you would think it should be a sort of co-equal currency. But what’s happening is that the safe asset pool provided by the euro zone is turning out to be smaller and more fragmented than the dollar zone.

In the U.S., if you want – in dollars, if you want, you know, safe assets, is you get U.S. Government Treasury bills. If you want safe long-term assets, you buy U.S. bonds. And yes, I know the U.S. is not – there are conceivable states of the world in which the United States Government – even the United States Government could default. But those are also states of the world in which the whole world goes to hell. So basically, there – my view is there is no safer asset. The only thing safer than U.S. Government debt is survival rations in your bomb shelter.

So the U.S. offers this large pool of safe assets. European governments issue debt, and German or French debt are pretty safe. The trouble is that it’s fragmented. There are these different nationalities, and the troubles of some euro zone members mean that you can no longer think, well, a euro bond is a euro bond. A Greek euro-denominated bond is clearly not as safe an asset, not a perfect substitute for a German bond. Even a Spanish bond, certainly an Irish bond is not equivalent. And so the euro zone has turned out to be a fragmented player in a way that the dollar zone is not. So I actually think the euro has suffered. The – my estimates of when the euro will actually be a sort of equal partner with the dollar have been pushed back a lot by the way this crisis has played out.

QUESTION: Hi, I have a question, (inaudible).

MR. KRUGMAN: I’m – because of the microphone, I can’t actually localize.

QUESTION: Okay. Am I (inaudible) – sorry.

MR. KRUGMAN: Oh, there you are, okay.



QUESTION: Hi, my name is Eva Schweitzer (ph). I work for the (inaudible) Zeitung. I have a question about General Motors. This whole – how shall I call that – controlled collapse, is this – isn’t it just a plot to bring down the unions?

MR. KRUGMAN: You know, I’m certainly – certainly, there are lots of plots to bring down the unions. I think what’s happened here, though, is that the trouble is that we do actually have a firm that’s not – you know, left to its own devices, would not be solvent. It’s got huge, huge legacy costs. It’s not – it’s caught up in this tremendous collapse and demand for durable goods of all kinds, including cars. So it’s in big trouble. And I don’t think the Obama Administration is trying to destroy the unions. The Obama Administration is trying to avoid a complete collapse without turning it into a monstrous subsidy program. It’s not an easy route. I mean, I understand it’s difficult. I do worry that they may be – I mean, I hope that they know better than me.

But – so this is one where I don’t have a really strong view. But I do worry that the controlled bankruptcy thing is still going to leave consumers unwilling to buy General Motors cars. You know, the trouble with selling durable goods – you know, nobody has a problem buying an airplane ticket on a bankrupt airline that’s operating in – under court protection because, you know, you take your flight and you’ve got it. But if you buy a car from a bankrupt automaker, you might worry that the company is not there to actually provide the spare parts or the service later on, so that becomes a tougher deal.

And it’s not clear to me that they’ve put enough incentives in there to make it work. So I’m worried this might not work. But I don’t see this – I mean, sure, large parts of the business press seem to get vastly more outraged at the idea of continuing to support workers who are making 60,000 a year than they are at giving away a, know, $180 million in bonuses to a handful of financial people. But I don’t think it’s a plot. I think, unfortunately, the union will suffer in the process.

QUESTION: Hi, Professor Krugman. (Inaudible) South African Broadcasting Corporation. If the United States is right and Europe is wrong in this instance, what would your advice be to African countries who are not able to leverage the kind of stimulus packages that the United States can?

MR. KRUGMAN: You know, there’s not a whole lot. In this world, smaller countries, smaller economies have got very little autonomy. It’s – unless they’re prepared to really shut down on globalization, and you really don’t want to do that until or unless things get very extreme. So right now, I don’t know what more to say, except realistic currency policies, trying to avoid – you can do a certain amount of domestic stimulus, but only a little bit because you have limited financial autonomy and – you know, and large import shares, as well.

It’s not an easy situation. You look at – again, we can look a little bit at crises past. There were a lot of condemnations of the austerity that was forced on East Asian countries in the late ‘90s crisis, and saying, oh, wow, you know, we’re not going to make that mistake again. And then we’re seeing that Eastern European countries are going through much of the same thing all over again. So it’s all turning out to be much more sort of an essential feature of the system.

I don’t think – I think there are things you can probably do at the margin. I have not studied South Africa, certainly. But no magic bullets. You know, if we go back in the 1930s, in the end, some countries did – even fairly small economies did manage to basically delink themselves and have recoveries. You think about Argentina. But they did so by adopting very strict exchange control – import control regimes, which did in the end, and certainly in Argentina’s case, then stump their growth for decades afterwards. So you really want to hold off on that, unless everything falls apart,which I have to admit these days looks like a possibility.

QUESTION: Professor Krugman, Dan (inaudible), a freelancer from Australia. Just in an allied question, what more can those kind of small economies do? I mean, do they just need to throw more at the wall to try and improve the situation when they’re so linked to larger economies that are their trading partners?

MR. KRUGMAN: Well, if you don’t have too much foreign currency debt, depreciation is an option. I mean, this is – the thing is not so much smallness as extreme openness. And can individual countries with a highly open economy still do better than their trading partners? Yeah, they can if they can pursue aggressive monetary policy and accept the resulting depreciation of their currencies. So if you look – even with – as some people have been pointing out, actually, Switzerland is an interesting case. Switzerland is actually – it’s certainly suffering, but it’s not suffering as much as a number of other European countries. And partly that’s because Switzerland is not part of the Euro. It’s not a heavy debtor in foreign currency (inaudible) and it’s able to accept – have an independent monetary policy, have a depreciation.

Last I looked, which was actually ten years ago, Australia was in somewhat the same situation. I mean, not – without the numbered accounts. But Australia, although open and small, had a lot of autonomy and monetary policy, was not heavily exposed in terms of foreign currency debt. And remember, Australia did ride out the Asian crisis in the late ‘90s remarkably well. So I think they’re – it very much depends on special cases. I mean, it’s amazingly non-generic, if I can say that. When we went through these crises in the late ‘90s we, for a while, thought all emerging markets were going to be the same. And every currency – everyone that experienced a speculative attack on their depreciation was going to have a catastrophe, just like Thailand or Indonesia. And then when the crisis hit Brazil, Brazil had a major devaluation of the real, and nothing terrible happened. Actually, the Brazilian economy began to recover. So you really want to – you have to look at the specifics of the country.

QUESTION: Professor Krugman, this is Herbert Bauernebel from the Austrian Daily Oesterreich. Every country deals with a crisis in different ways. The story in Austria, of course, is its huge exposure by its bank to Eastern European debt, which is estimated as high as up to 80 percent of its GDP. How – some media have speculated that Austria, one of the wealthiest countries in Europe, might go actually bankrupt. What is your take on that? How real are those dangers, and how do you evaluate the crisis in Eastern Europe? Some people have compared it to the Southeast Asia crisis of the ‘90s.

MR. KRUGMAN: Oh, the crisis in Eastern Europe is at least as bad as the East Asian crisis of the ‘90s. It’s – and it’s very much – it’s a replay. It’s almost astonishing. I mean, look at Estonia, which, admittedly, is not a very big economy, but it’s almost – it’s as if somebody had read the analytical papers, exploring the Indonesian collapse or the Argentine collapse of a couple of years later, and decided that we’ll let – let’s play this all over again, let’s replicate it. I mean, it’s – it really is the same foreign currency peg, ultimately unsustainable, large foreign currency denominated debts. The whole thing is playing out right like it.

And the scale of the output collapses in Eastern Europe are looking fully comparable to East Asia, in fact, in some ways looking fully comparable to the Great Depression. And it is ugly. It’s – Austria with a large exposure there, I mean, I haven’t done the sums, but it does look pretty scary. It looks – look, we know that – we’ve seen one advanced country essentially go bankrupt. Now it’s a tiny one, it’s Iceland, but that just shows that it can happen, even to advanced countries. Ireland looks pretty bad because of large financial exposure. And Austria would probably be my third candidate in those leads. I don’t have a – it’s just – it’s a huge exposure to a very, very troubled region. Maybe expanded IMF facilities will provide enough cushion that the thing won’t actually really go that bad.

But yeah, this is – and for those who know their Great Depression History, you know, we’re all obviously thinking Credit-Anstalt and the whole thing. So it’s – it is pretty bad.

QUESTION: Good afternoon. (Inaudible) from the French newspaper (inaudible). I was wondering, do you consider the G-20 London meeting as a real success for the Obama Administration or just a diplomatic trick (ph)? And also, do you think Barack Obama will ask and will have still strong support within the Democratic Party for its – for his economic policy, given your strong criticism on the Geithner plan?

MR. KRUGMAN: Okay. So the G-20 meeting was infinitely more successful than the typical international meeting. That’s because it actually did accomplish something, so the denominator is zero. The normal meeting accomplishes nothing and that this G-20 meeting actually did accomplish something positive, fairly important. I mean, it created a – it substantially enhanced the resources of the international financial institutions, not as much as the headline number, but substantially – several hundred billions dollars of genuine new money, which makes a big difference, particularly for the smaller economies. It made a big difference for Eastern Europe, in particular. So that’s – that’s a major achievement.

Now – so compared with what a lot of us were afraid of, which would be a totally empty meeting, it was much, much better. For those who thought that there might actually be an agreement on international fiscal stimulus or for those who thought that there might actually be an agreement on the shape of future financial regulation, obviously, the meeting didn’t do that. So – but it was – I think if you’re realistic about what actually happens at these meetings, it was actually pretty good. So, no, I thought it was a relatively happy outcome.

If you look at what’s happening, it’s a very important – actually, you know, you saw – so I get on the cover of Newsweek, which is a very bad sign, and with no real substance in the article, but you know, the critique that Obama is getting within the Democratic Party or certainly – well, or – I guess there are people on all sides, but the critique he’s getting from people like me is that he’s not doing enough. So it’s not a critique that says, oh, he’s off totally on the wrong track. It’s not, oh – you know, it’s not we’re going to find ourselves – that disaffected progressives are going to start turning to the Republicans. I mean, this is a case where the criticism is that Obama is not being progressive enough, he’s not being proactive enough. That suggests that if he – certainly people like myself, if somebody comes back – if he comes back and says, okay, I need more money for a differently designed, more aggressive bank rescue plan, I’ll be cheering it on. If he comes back and says, I need another fiscal stimulus, I’ll be cheering it on.

So I don’t see – you know, his political, his partisan opposition is all on the opposite side. There’s no sympathy between people like myself and people, you know, that the Republicans who wanted no stimulus plan at all or a stimulus plan that consisted entirely of long-term tax cuts for the affluent. So it’s – I think you need to be a bit careful. I get this stuff, I mean, I get people saying, aren’t you doing the Republicans’ work. And no, I’m actually trying to push Obama a bit to the left here, right. So this is a very different thing.

QUESTION: Hello. My name is (inaudible). I’m with a Dutch newspaper NRC Handelsblad. I got two actually pretty simple questions for you. You’ve been saying over and over again, it’s not probable that we will end up in a new depression, in a new great depression. But you said it’s still very possible. Can you lay out that case again?

And then the second question is even easier, because it doesn’t have that much substance, but what does it feel like these days to be the economic superstar of the world?

MR. KRUGMAN: Okay, I will answer the second one first, which is not very different from the way it did before, right. I’ve got too much work. I need to lose 30 pounds, whatever, you know, but nothing much changes. And it’s – so it’s no big difference, so whatever. It’s – you know, I think anyone who thinks that it must be, you know, joy all the time, it’s – life goes on.

All right, not the Great Depression. All right, we actually – there’s actually been important work. I was a little bit stunned. Barry Einchengreen and Kevin O’Rourke have been doing – two economic historians who also know contemporary events, have done this work where you’ve been able to use available measures. And it turns out that if you look at things like industrial production, world trade, we’ve actually been falling faster in this crisis than the world did in the Great Depression.

So if we’re just asking, you know, could we have something like the great slump in world output that took place from 1929 to 1930, we are having it. It’s – actually, it’s a full – full match. So I like to quote this magnificent essay by John Maynard Keynes that was published in late 1930, called “The Great Slump of 1930,” talking about how terrible things are and where he says we have magneto trouble which is, roughly speaking, you know, that small electrical part in the car that – but enough to stop it.

We are basically in the world that matches the world the Keynes was describing then. However, what made the Great Depression really so terrible was what happened in 1931, when the world financial system just collapsed, when you had the wave of bank runs in the United States, when you had Credit-Anstalt setting up a wave of bank runs in Europe, and when because of the attempts of countries to defend the gold standard, they actually raised interest rates in the face of a severe economic slump.

We’re – I still think we’re not likely to see anything quite that bad. I think we’ve actually stepped in to at least prevent a collapse of the financial system. And I don’t think we’re going to see the kind of perverse monetary policy that took place in 1931. I’m not dead sure of that, and we can ask how much – how certain are we that that’s what made the difference. But I still think that this looks like a terrible, terrible world recession, the worst since the Great Depression. But unless we have a replay of the terrible events of 1931, if not a full second great depression.

QUESTION: Good afternoon. (Inaudible) from China’s 21st Century Business Herald. You also go to China next month, so my question is what do you think is the biggest risk of Chinese investment in the U.S. and how China can better manage the risk? Thank you.

MR. KRUGMAN: Well, China has overwhelmingly bought U.S. Government debt and it’s almost an agency debt, which is sort of implicitly guaranteed. So China is not facing the risk of large capital losses measured in dollars. And the major risk is if the dollar does get a lot weaker against the basket that really measures what China wants to buy. And China has clearly gotten itself very deeply into dollars to such an extent that it can’t even really diversify without producing – without triggering the same capital losses that it fears. So that’s a significant risk.

Now it has to be put in some perspective. It’s – China is not going to lose 80 percent of its investment. It could, in effect, end up losing 20 or 30 percent because of the decline in the dollar. But that’s not a – you know, it’s not catastrophic, except it’s – it just looks like China has been spending in recent years 10 or 11 percent of its GDP, acquiring very low, probably negative return investments. You know, unless you believe the people who think that there’s going to be U.S. hyperinflation, I don’t think it gets worse than that and I don’t believe that. So it’s – it still looks to me like a really – if I can say, it was a really dumb strategy to acquire all those dollars. But it’s not a disastrous strategy. It’s just kind of a major waste of funds.

QUESTION: My name is Christina (ph) (inaudible) from Hungarian National Television. And I’d like to ask you to follow up a little on the almost tripled IMF resources. What do you think the significance of those newly available resources are for emerging markets like Hungary in really deep trouble? And don’t you think that there is dangers, moral hazards to them, a new development at IMF to ease up terms for loans on the long run for these countries?

MR. KRUGMAN: Okay. So on the first part, there’s – the ability to provide, you know, liquidity to countries in trouble is – now is substantially larger. We had a situation where we’re looking at economies that were – that are desperately in need of basically just liquidity. And if I believe – again, if I believe the research, it says that countries that have large reserves relative to their short-term external debt, really do suffer a lot less in these crises, now in effect the IMF is standing behind these countries with several hundred billion dollars of additional stuff that can serve as a supplement to the reserves.

So if you put this together, ought to make a substantial difference. It ought to give countries the ability to have much less acute, much less sort of – I’m trying to think of the word here, but not – less draconian policies of response, better chance of adjustment. And you know, looking at crises past, we do see that, you know, if South Korea or Thailand or probably even Indonesia have been able to spread out their adjustment a bit more, the crisis would not have been nearly as severe as they were. So if we can do the same now for Hungary or Ukraine, we probably can help some in this crisis.

Moral hazard, you know, I think moral hazard gets over emphasized. It’s real in some cases. If you something like have a deregulated thrift institution in the United States, which have negative capital and government guarantees on their deposits, then you do, in fact, create a monster that ends up swallowing 4 percent of GDP. And the PPIP, the Geithner plan, is almost more or less designed to create a lot of moral hazard for people buying troubled mortgages. But the idea that people are going too make international investment decisions largely based on the belief that the IMF will bail them out if it goes bad, there’s never been a whole lot of evidence for that. And I think that’s thinking – that’s – actually, in a way, it’s almost attributing too much rationality.

I don’t see any sign that people who are pouring money into the Baltics this time around were doing so because they thought the IMF was going to rescue them when it all went bad. They poured it in because they were caught up in the animal spirits of the bubble and didn’t really think that it could ever go wrong. So I think the moral hazard gets overused as an argument against doing anything now. And I’m not worried about that aspect particularly much.

QUESTION: Hi, yes. (Inaudible) German TV and Radio Productions. I have two questions. The first: Why do you think it’s not more talk about fraud? If the plane goes down, there’s a thorough investigation. With the banks, not so much.

The second one: After the crisis, do you think which areas – regions in the U.S. – will be winners or losers, and why?

MR. KRUGMAN: Okay, so you mean geographical regions?


MR. KRUGMAN: Yeah, okay. So, okay, let me – it’s a good question why we’re not talking more about fraud. And part of the answer is that, you know, that the people managing this – are managing the crisis response are – you’re a little – it’s a little bit – if there’s a fire, you try to put the fire out and then you hunt for the possible arsonist later. So there is a certain amount of going at this feeling that searching for villains is not the highest priority.

Though I think that’s probably overstated. We actually – since there is some possibility that the people you’re dealing with are, in fact, the villains. But – and then there is – look, there – some of us have responded to this whole thing by saying, you know, gee, this financial thing that we created over the past 25 years really is – was a big mistake, and that there was a lot of exploitation, a lot of people making great amounts of money, if not actually deliberately engaged in fraud, nonetheless engaging what turns out to have been equivalent of fraud.

But that’s not the attitude in Washington – not yet, not even now. Even now – maybe it was inevitable, but even now, Treasury Department turning for expert advice on how to deal with this crisis, turns to people who were very much part of the system that created the crisis. And just – that’s not an environment in which a search for fraud is something that’s on people’s minds. Things would have to get a lot worse before that becomes the priority.

Which, in a way all leads to the second. I mean, what I think – one thing that’s clearly going to be hurt – regions that are clearly going to be hurt is where we are right now, in New York, as it is – or New York as it was a year and a half ago was a city that had really become a mono-culture in terms of its economy, all built around this supercharged, supersized financial industry. And we now have strong reason to believe that that giant financial industry was actually probably producing negative marginal product for the economy as a whole. So we’ll go back. But if we go back from finance being 8 percent of GDP to finance being 4 percent of GDP – it probably won’t happen that sharply, but probably should. But if that happens, a lot of those 4 percentage points of GDP that we give up will be given up on the island of Manhattan. So this is not good for the economy of New York.

Otherwise – and of course, also, obviously, the most bubblelicious parts of the country are going to take probably a few decades to become desired destinations for large-scale real estate investment. It’s going to be – I wouldn’t be betting on a recovery of employment in Fort Meyers/Cape Coral, Florida anytime in this next decade anyway. So that – but that’s the – but I do work – you know, I live in greater New York, out there in New Jersey, and I guess I’m a little bit of a metro New York patriot, and I think that in that sense this is not good news for my local economy.

MODERATOR: One more question on that side, and then we’ll go to Washington.

QUESTION: May I? Yeah, I’m (inaudible). I work for Helsingin Sanomat, the largest paper in Finland. Thank you for your illuminating book.

I have one big question and one small one. Do you expect the modern capitalism as we know it to change as a result of this crisis, or are we going to go back to what we were doing pretty much, same old same? And second, a smaller question, does it bother you that the President Obama hasn’t invited you to White House to share your views on how to tackle the crisis? Thank you.

MR. KRUGMAN: Okay. You know, on the second part, I mean, do people in the Administration read what I write? Yes, they do. Do they sometimes call me to berate me for what I’ve written? Yes, they do. So it’s not that I’m feeling ignored, and I don’t see – in some ways, there’s less purpose in having me at a meeting than anybody else on earth. I’m the most visible. My opinions are there in the column, on the blog every day, so that no one – I don’t need to be brought in. So I don’t – that doesn’t – that’s not an issue.

The – this crisis or the next one – I guess the way I’d look at it is if we don’t make some major changes, then it’ll happen again, that if you look at the – actually, I have a chart in the book called Greenspan’s bubble, showing that the last 20 years really were – we were lurching from bubble to bubble. And if we don’t make major changes, we’ll lurch onto the next one, and the next crisis will probably be even worse than this one.

But assuming we do something, then we are going to make some major changes. I’m not sure that it’s capitalism exactly that changes, it’s mostly financial. I mean, there are other things that I would like to see changed. I’d like to see a more – from a European point of view, a more social democratic arrangement in the United States with a much stronger social safety net. That might happen. I hope it does.

But what I think will happen is that, like our grandfathers, we will discover that the financial system needs to be really quite carefully regulated and supervised. I wrote about that recently. We had 50 years of boring banking because of the changes that were made during the 1930s, and that was a system that was quite stable. And from about 1980 onwards, people said, oh, but it’s discouraging initiative, it’s discouraging innovation, and so we opened it up and it became a much more exciting thing, and then it produced disaster.

So what we go back to is some 21st century version of boring banking, with a much more tightly circumscribed financial sector. That won’t change the essential nature of capitalism all that much, but it will be a different economy with less swashbuckling and fewer extremely, extremely rich people, but otherwise still a market economy.

MODERATOR: Okay. Go ahead, Washington.

QUESTION: Can you hear me?


QUESTION: Thank you, Professor. Just for the PPIP program, what do you expect that program will do? I mean, will that solve the pricing problem, you think? And also, there is another program – I mean, say the home ownership, the homeowner remodification program, to rewrite the loans. What if these two programs conflict each other? And what should be done to avoid that? And also, if this program, PPIP, does not work, in the future what do you recommend? Say, partial nationalization again or anything? What’s your favorite?

And the second question is about financial regulation. What do you think of the (inaudible) proposal about a risk – systematic risk regulator? And also, here we don’t see a lot of proposals against – concerning credit rating agencies. Why is that?

Thank you.

MR. KRUGMAN: Okay. I think that was more than two questions. Anyway – (laughter) – let me answer a couple of them anyway.

PPIP – what I’m guessing right now is that it will – is that not much will happen. I mean, you know, I’m hoping to be proved wrong here, but what I – what I’m guessing right now, based on, you know, little bits of stuff we have, is that – is that even with 93 percent government financing, the amount that the private investors are willing to pay for troubled loans will be less than the amount – the minimum for which banks are willing to sell them. The banks will be wanting to keep them on the books at very high prices, and it’s just going to not go anywhere, you know, which is – this is a – what I’m guessing is that the PPIP will actually end up looking like the TALF, which is – there were are a lot of people screaming about what a terrible thing the TALF was going to be and what a bad deal for the taxpayers. I actually thought that was a better program than the PPIP, but basically it’s not having any takers. It’s just not going anywhere.

Now, I could be wrong about that, particularly if there – the PPIP can be gained if financial institutions can find a way to essentially buy off their own debt and – one way or another. Then there will be takers, but then it could be really bad. It could be a really bad rip-off for creditors. Actually, Jeff Sachs has written about that. The – bad deal for taxpayers is what I mean, but I don’t think the PPIP is going much anyplace. The home modification stuff, you know, I’m in favor of that. I don’t think you should expect miracles. I’m not sure how it interacts with the PPIP, but I think that’s – you know, it’s something good to try.

Systemic risks regulator, sure. I’ve never been able – and this is a failing on my part. I’ve never been able to decide what I think about basically reorganizing the structure of regulation. I’ve never been able to decide for my own purposes which org chart diagram is better, so I don’t really know about that.

What I really think we need to do, but I don’t hear sentiment for in the Administration yet, is we need to do something that restores a little bit more incentive on the part of credit originators to actually watch the quality of credit. I would be very much in favor of a regulation that requires lenders to hold onto some portion of the original loan so that you’re not going to allow full securitization. I think that’s what you really need. It’s not – sure, you need somebody to oversee systemic risks. But look, if the Fed had been the systemic risk regulator, it would have looked at the system in 2005 and said, well – and Greenspan did say in 2005, which is everything’s fine, the modern financial derivatives have made the system more stable. So it wouldn’t have actually seen the crisis coming.

I’m not sure – I think there was another question in there, but I’ve lost it, so I’m going to stop there.

QUESTION: Sarah Jacob, New Delhi Television. Mr. Bernanke is of the view that the recession will end this year. President Obama said last week that he sees a glimmer of hope. Do you agree, or is this premature optimism?

And two, many believe that India and China will perhaps move ahead of its competitors, say Europe and the U.S., at the end of this. Do you agree? And what are the challenges these countries face, especially India?

MR. KRUGMAN: Okay. Bernanke may well be right that the recession will be declared over – that retrospectively the National Bureau of Economic Research will declare that the recession ended sometime late this year. Because basically, we define a recession – you know, there’s no formal definition in the United States, but we define a recession as everything’s going down. And as soon as some indicators start going up, we declare it over. You know, the 2001 recession was declared over in November because, sure, in fact, industrial production and GDP started moving slightly upwards at that point. Unfortunately, unemployment continued to rise for another year and a half after the recession supposedly ended.

So I wouldn’t be too surprised to see that we have an official end to the recession in, let’s say, September, but that unemployment continues to rise throughout the whole of next year. So that would be – that would make Bernanke right, but would not mean that we were actually, you know, sort of – that wouldn’t feel like we’d had a recovery in any real sense.

The reason why this might happen is if we look at – it’s kind of – there are sort of these shocks and then there are knock-on effects. We’ve had a sharp fall in consumer demand because people have suddenly realized that rising home values won’t actually provide for their retirement. We’ve had the collapse of the housing bubble. Barring future – barring additional shocks, that produces a series of knock-on effects which eventually run out of room. So you – consumer demand falls further as unemployment rises, business investment is cut back because you have excess capacity.

But it does reach a sort of bottom. And if you actually reach a bottom, then you actually expect some partial rebound, because part of what’s depressing industrial production particularly is people – is excess inventories. And so once the inventories are run down, production turns up. So that would be the source of recovery.

Now what we don’t know is whether there are other shoes to drop, other stuff’s going to happen, if Austria goes into default or if there’s another major set of financial blowups, if commercial real estate turns out to be even worse than we now think it is, and so on, then there could be another downward leg. So if you look at the history of the Great Depression, there were actually several pauses in the downward slide of the world economy, one in – particularly in early 1931. Things were actually turning slightly up if you look at industrial production, and a lot of people said, oh, the worst of this is over and then it got even worse again.

So I don’t know that this will be the end, but it’s not crazy to think we might see an end. The thing, though, is that these modern – the last two recessions of the United States both led to extended periods of unemployment, and in some ways, of intensifying suffering because prolonged unemployment does a lot of damage long after the recessions were officially over. And there’s every reason to think that will happen again, that – remember, just to go back, like 19 – you know, Bill Clinton ran on the economy and got elected in 1992 because people perceived a terrible economy. That recession had supposedly ended the previous year, but it didn’t feel like it, and that’s probably where we will be well into next year and probably, I would guess, into 2011.

MODERATOR: I think we have time for only two more questions, so Louise and then Karen.

QUESTION: Hello, my name is Louise Vit (ph). I’m from a newspaper in Denmark. I was hoping that you’d comment on the debate about bankers pay compensation and the bonus system. Do you think that actually contributed to the crisis, and what should be done about it now? How should it look in the future? Thank you.

MR. KRUGMAN: Yeah, I can answer the first one easily because the – yes, it did. I mean, the system of financial compensation produced an enormous reward, personal reward for creating the appearance of success, whether through actual fraud or at least by taking on risks that nobody understood. And as long as it went well, you got paid enormous amounts, and if it eventually blew up in everybody’s face, you still end up personally quite wealthy. The incentives – there is moral hazard – I mean, the incentives are enormous to go out there and leverage up and take risks and – even if it ends up badly, you personally have done very well.

And it’s not just – it’s not just the structure; it’s the scale. So even if you don’t explicitly have the bonuses based on short-term profits, the sheer scale of the amount of money you can make if you’re perceived to be a successful banker leads you to take enormous risks. So back – you know, this famous line from Michael Jensen back in the ‘80s was advocating more incentive pay, saying if you pay businessmen like bureaucrats, they’re going to behave like bureaucrats. Right now, we kind of wish that bankers had behaved like bureaucrats, right? I mean, they – it’s been a real disaster, the way it works.

Now what you do about it, that’s harder. I think part of the point is that if you have strong financial regulation, then it also – banks will end up paying their top executives more like bureaucrats. And beyond that, I – you know, things – now this is speculation, but I do wonder to what extent, actually, high marginal tax rates, which we – which we had during the ‘50s and the ‘60s were actually a deterrent to financial craziness. It’s one thing to go and take thing – you know, take actions that make a lot of money in the short run but end up blowing up your institution if you get to keep 65 percent of it or 85 percent if you’re a hedge fund manager, another if you only get to keep 20 or 30 percent, which was the case under the previous tax codes. So – but I – there are no easy answers. It’s very – you know, it’s very – we know that it’s very hard to just legislate bankers’ pay.

Oh, by the way, I did miss the rating agency. That’s also – it’s clear that the rating agencies played a terrible role in this, but I also haven’t figured out exactly how you deal with that.

QUESTION: Thank you. Arrow Yong (ph) from China’s Xinhua News Agency. Earlier, you said that in stimulating the economy, Europe is wrong and U.S. is right. So do you think China’s government has done right thing, or is there anything that China hasn’t done right apart from holding too much U.S. treasuries? The second --

MR. KRUGMAN: Yeah, okay. Yeah, well, I – no, let me say China – I’m trying to – China has announced very aggressive stimulus. And right now, it’s announcing extraordinary results – huge increase in bank lending and the economy turning around. And if all of this is actually true, then China has done a very good job. You may notice there’s a little skepticism here. I guess I just have to say that I’m – these results, the economic turnaround is – as reported, is coming so fast that it’s a little hard for me to believe, maybe because I’m too accustomed to the pace at which things happen here. It’s just hard for me to believe that they’ve been able to achieve that much turnaround of lending and business sentiment in such a short time.

But if it’s true – I mean, what China says it’s been doing is a – is what, in a way, I’ve been urging, you know, the Obama Administration to do, to hit it really hard – massive, massive stimulus, enough to turn it around. And so I guess I’m hoping to do a little detective work and, more to the point, talk to other people who really have done the work and figure out how much of it is actually right. But one thing you can say is certainly, China is not in the group of countries that have been saying, oh, you know, we just need to let this thing run its course. They certainly have been trying to do something about it.

MODERATOR: Thank you so very much. I know that we could be – we could go on with questions for another hour. But I want to thank you very much for coming.

MR. KRUGMAN: Thank you so much.

MODERATOR: It was a pleasure. I just – two plugs, everybody just hold on a second, it’s not a rock concert. Just two plugs for tomorrow. The Special Inspector on Iraq Reconstruction will be here via digital videoconference at 2 o’clock. At 3 o’clock, we will have Dr. Ben Steil. Everybody settle down. Don’t attack the professor, please. And at 3 o’clock, Dr. Ben Steil will be here talking about money markets and sovereignty.

With that, the professor has a very, very short time before he needs to leave. So if you’ve already asked a question, I ask that you let your colleagues go, okay? Thank you very much.

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