Paul Krugman on Euro Rescue Efforts 'Right Now, We Need Expansion'
In a SPIEGEL interview, Nobel Prize-winning economist Paul Krugman argues that this is not the time to worry about debt and inflation. To save the euro zone, he argues that the European Central Bank should loosen monetary policy and the German government should abandon austerity.
SPIEGEL: Mr. Krugman, does Greece have to leave the euro zone?
Krugman: Yes. I don't see too much alternative now. It's going to be terrible in the first year if they do leave. So I am really reluctant to say that it's a little bit like shouting "Fire!" in a crowded theater, but what is the realistic option here? It's not as if anything anyone's proposing has any hope at all of getting them out of the mess they're in.
SPIEGEL: If Greece should leave, will this finally contain the euro crisis or, rather, make things worse?
Krugman: What happens if Greece leaves? Then you have again a bank run in other peripheral countries because they've set the precedent. But, again, that could be contained with lending from the ECB (European Central Bank). What has to happen is that the ECB has to be willing to replace all euros withdrawn as is necessary. And I think the case we're making for that lending becomes a lot easier because the Greeks were actually irresponsible. The Greeks actually did behave badly, and so the political case for unlimited exposure to Greece is very hard to make. A much easier case to make is for Spain and then Portugal and Italy, all of which did nothing wrong on the official side. So you could argue that the bad actor has been ejected, but we need to save the good actors.
SPIEGEL: But is the ECB ready to act in the way you propose?
Krugman: That's the mystery, right? We will see a big flood of money out of Spanish and Italian banks, and then the ECB has the choice to accept a big increase in its exposure to those countries. The ECB lending that much money with ultimately the Bundesbank on the hook for a lot of it -- that seems impossible. But if you say, well, the ECB won't be willing to do that, then the euro blows apart. And allowing the euro to fail -- that's impossible. But one of those two impossible things is going to happen.
SPIEGEL: Could Europe have avoided the current situation with more decisive actions early on?
Krugman: Greece was probably a doomed prospect from the moment that we got the truth about their budget. Spain, which is really the epicenter, is still savable.
SPIEGEL: In your columns, you have repeatedly criticized Chancellor Merkel for her management of the European crisis. Do you blame her for the situation we are in right now?
Krugman: She has certainly drifted; she has temporized. Could she have done more? I don't know. I just have the feeling that we really are looking at the gears of fate grinding along.
SPIEGEL: But you have repeatedly pointed out that Germany's pushing for austerity will lead Europe on a death trip and that prosperity through pain is a fantasy.
Krugman: That's right. I thought it was obvious from the beginning that this is never going to work. If the policy makes any sense at all, it's through mass unemployment, driving down Spanish wages. How many years is that supposed to take given that we've seen that, even with close to 25 percent unemployment, you will have a glacial pace of wage adjustment?
SPIEGEL: You call austerity a "zombie" economic policy.
Krugman: Yes, the whole point about zombies is that they just keep on champing forward no matter how many times you think you have killed them. We've got really almost two and a half years of experience with how these policies actually work, and the fact that this is still the recipe that is being preached despite all the evidence that they are not working.
SPIEGEL: Doesn't it just take some time for the austerity measures to deliver results?
Krugman: Where's the evidence?
SPIEGEL: Greece's economy grew in the first quarter.
Krugman: That's possible. Greece has actually achieved some improvement in cost competitiveness. But think about how long it would take to fully restore. The thing about unemployment at these levels is that the damage is cumulative. People's lives are being destroyed as their savings run out.
SPIEGEL: So you think we should go the other way and spend our way out of trouble?
Krugman: Any individual country, except Germany, doesn't have this option. It's not as if the government of Spain can simply reverse and go to Keynesian policies. They can't fund that. Put it this way: If you're the prime minister of a small European country, even a fairly big one like Spain, you have no option. Your options are to have some form of austerity, possibly while protesting, or simply to leave the euro. But Frankfurt and Berlin have choices.
SPIEGEL: What do you want the ECB and the German government to do?
Krugman: First of all, give the green light to the ECB and say: Price stability is the mandate, but it's not defined. So the reality is we're going to need to see 3-plus percent inflation over the next five years. No more tightening, no more raising interest rates at the first hint of inflation, even if it's obviously a commodity blip. If anything, cut interest rates. Open-ended lending to governments and banks.
SPIEGEL: And Berlin ...
Krugman: ... should not be doing austerity in Germany. I'm tempted to add that I wish for all of that and a pony as long as we're wishing for things we don't expect to get.
SPIEGEL: And maybe that's a good thing. Because 4 or 5 percent inflation may be fine for a short while, but how do you make sure that it doesn't rise to 7 and 8 percent or more once the expectation is there?
Krugman: It's not actually hard. Just raise interest rates once it's creeping up to the level you don't like. I mean, people have the notion that inflation just explodes out of nowhere. It just isn't true. It just hasn't happened. If you actually look at the histories of the inflations that we've had, hyperinflations come from a very different story. They come from governments that can't raise revenue and just rely on the printing press.
SPIEGEL: But if inflation really isn't that big of a problem, why is everybody so afraid of it?
Krugman: For one, it's that central-banker culture. Central bankers almost define themselves that way. Their job is to take away the punchbowl just as the party really gets going. And, in the current circumstance, they seem to be eager to take away the punchbowl even though there isn't any party to begin with. Plus, in Germany, you have this weirdly lopsided historical memory where everyone remembers 1923, everybody remembers Weimar. And nobody remembers Chancellor Brüning (Germany's chancellor from 1930 to 1932, who pushed austerity measures).
SPIEGEL: The US has followed a looser monetary policy for about 10 years now, but the debt problem is still there.
Krugman: We do not have a current federal debt problem. We have a private-sector debt problem. But, if you say the US has been more inflationary, if you actually look at average inflation rates over the past 10 years, they're not very different between the euro area and the United States. They've both been in the two-ish percent range.
SPIEGEL: So you would say that, in Europe, it's the ECB that needs to act and, in the US, it's government stimulus that is really needed to get things going?
Krugman: If there was a European government, I'd be arguing for stimulus from that European government. But Europe has a special problem, which is the single currency without the single government.
SPIEGEL: So, if you could have a stimulus in Europe, how much money would you need?
Krugman: Again, the US and Europe are not that different. I would say a similar number, and that's 300 billion. So we're not talking trillions of fiscal stimulus.
SPIEGEL: What do you think about the growth programs that are currently being discussed within the European Union? Are they enough?
Krugman: This is a water pistol against a charging rhinoceros. This is ridiculous. These are ludicrous, trivial things compared with the scale of what's going on.
SPIEGEL: Still, we aren't really sure that the almost $800 billion in the US really worked.
Krugman: First of all, 40 percent was tax cuts, some of which were tax cuts that were actually already baked in, so it wasn't real. It was actually 700 real, of which a large part was still tax cuts. Then, if you want to think about it, it's over a roughly three-year period. It really was not a big deal if you look at government spending in aggregate, state and local as well, where there was no stimulus at all. There was a rise in spending on food stamps and Medicaid and unemployment insurance -- but those are responses to the crisis, not new programs. So the answer to the question of why stimulus didn't do more here is: What stimulus? We never had them.
SPIEGEL: More stimulus also means more debt. Many European nations, as well as the US, are already drowning in debt.
Krugman: I'm not saying that I don't ever care about debt, but not now. If you slash spending, you just depress the economy further. And, given the low interest rates and what we now know about long-run effects of high unemployment, you almost certainly actually even make your fiscal position worse. Give me a strong-enough economic recovery that the Fed is starting to want to raise interest rates to head off inflation -- then I become a deficit hawk.
SPIEGEL: So, for now, we should just ignore the huge debt burdens?
Krugman: That's right. It's quite amazing that we're giving priority to the imagined threat that the bond markets might lose faith even though they give every indication of not being worried at all, given the reality that millions of people have been unemployed for more than a year and the almost certain long-term damage that that's inflicting.
SPIEGEL: But we can't just kick the debt can down the road and let future generations deal with it. The debt has not been shrinking even in good economic times.
Krugman: That's not true. We went into huge deficits when the economy plunged, and this is the time for huge deficits, not later. And it's not a date; it's a condition. When the economy has recovered sufficiently so that we're no longer in the liquidity trap is when you start to worry about debts again. John Maynard Keynes said: "It's the boom, not the slump, that is the time for austerity." And we're definitely not in the boom yet.
SPIEGEL: In your new book, you are actually saying that we are in a depression.
Krugman: I'm using the term advisedly. It's not as bad as the Great Depression. But the standard language of recession and recovery is actually harmful here because it makes you think that, because we're not actually in a recession, things are okay. But they are not. Depression is a period of high unemployment, of really lousy conditions -- and that describes us right now.
SPIEGEL: So, are we looking at a lost decade in the West similar to what happened in Japan?
Krugman: In fact, we're doing worse than the Japanese every day. We are actually having a steeper slump, more suffering, larger output gaps than the Japanese ever suffered. Those of us who were writing critically about Japanese policy 10 years ago ought to all go to Tokyo and apologize to the emperor. Not because their policy was any good -- their policy was terrible -- but our policy is even worse.
SPIEGEL: What has almost been forgotten in recent months -- over all the criticism of the political crisis-management -- is the role that banks have played in the crisis. News about the heavy trading losses of JP Morgan has brought this back into the discussion. It seems like nothing has changed on Wall Street.
Krugman: The Volcker Rule is not yet in effect. I think that, if that had been in effect and defined, it might have stopped this. Hopefully, this turns out to be the last gasp of banks behaving in ways that they will not be allowed to in the future. (JP Morgan Chase CEO) Jamie Dimon is saying he will not, in fact, budge from his antiregulation position at all.
SPIEGEL: But the issue of banks being too big to fail has yet to be adequately addressed.
Krugman: A lot of the banking problem is not too big to fail. Lehman wasn't all that big. But there is clearly more of a political-economy problem of too-big-to-fail banks, which is that they get too powerful and are in a position to undermine reform. The problem with JP Morgan ... is not as much that they are too big to fail as the fact that they are so damn big that they can probably continue to drive a watering-down of financial reform even though they just messed up so badly.
SPIEGEL: But aren't banking issues to some extent a by-product of loose monetary policies? That was one reason for the financial crisis in 2008. Even now, having central banks pour money into the system could lead to new financial bubbles, which could trigger new problems within the financial system if they were to burst.
Krugman: I am not convinced that excessively loose monetary policy was actually at the root of the problem in the first place. And then, even to the extent that you think that excessive optimism or exuberance got us into the crisis -- and, therefore, we must be very careful to avoid anything like that ever again -- that's fighting the last problem. Right now, we need expansion.
SPIEGEL: The European banks are already in trouble.
Krugman: What's actually happened now is that a lot of the European banking system is basically heavily invested in the sovereign debt of its own countries. And so it's all tied together. I'm not worried about European banks; I'm worried about Europe. If the euro survives, then so will the banks.
SPIEGEL: Shouldn't the close ties between banks and sovereign debt be cut?
Krugman: You can't cut now. There's a fire, and we need to pour as much water on the fire as possible. Let's worry about reconstruction afterwards.
SPIEGEL: Mr. Krugman, thank you very much for your time.
The interview was conducted by Martin Hesse and Thomas Schulz