SPIEGEL: You have accused the German government of "boneheadedness" in its approach to the financial crisis. What are Chancellor Merkel and her Finance Minister Peer Steinbrück doing wrong?
Paul Krugman: They are still thinking in terms of the world as it seemed to be a year or two ago, with inflation and deficits the major threat. As a result, they are failing to appreciate the severity of the slump -- and are wasting crucial time, for Germany and the rest of Europe.
SPIEGEL: What could be the reasons for their reluctance?
Krugman: I suspect there is a tendency to view any sort of European expansion as a way to get Germany to subsidize the rest of the EU. And maybe it's just lack of intellectual flexibility.
SPIEGEL: Germany's government is worried tax cuts and stimulus packages might just evaporate. Is there any truth to this way of thinking?
Krugman: There's reason to fear that tax cuts would be ineffective. But that's a case for a better designed program, not for doing nothing.
SPIEGEL: How do you view Merkel and Steinbrück's fear that Germany would end up paying for other peoples' mistakes and problems?
Krugman: Understandable -- but it's petty to worry about this when the European economy, very much including Germany, is in grave danger.
SPIEGEL: Unlike Americans, Germans tend to spend less and save more. Is there a danger any kind of tax benefits might just end up in saving accounts?
Krugman: Yes, there is. That's why the focus of a program should be on government spending as much as possible. But the perfect is the enemy of the good -- we are in a severe plunge, and must do as much as possible quickly.
SPIEGEL: Are there no alternatives?
Krugman: In normal times monetary policy, combined with automatic stabilizers, is sufficient. I'm opposed to discretionary fiscal policy in normal times.
SPIEGEL: And what is different right now?
Krugman: Monetary policy has lost traction! When interest rates are either at the zero lower bound or quickly approaching that point, fiscal stimulus becomes essential.
SPIEGEL: What would you advise the German government to do?
Krugman: I won't try to prescribe details -- I am still working on the US situation. But a significant stimulus, soon, is crucial whatever its composition.
SPIEGEL: How much do German policies matter in the fight against the global financial crisis?
Krugman: Europe has a major coordination problem: The trade-off between deficits and output is much less favorable for any country acting unilaterally than for the EU as a whole. So cooperation is essential. But if Germany, the largest economy, refuses to go along, there will be no cooperation. Events have given Germany a strategic policy importance disproportionate to its size.
SPIEGEL: What's the price of inaction?
Krugman: A very, very severe slump, with worse unemployment than at any time since the 1930s -- and quite possibly a Japanese-type lost decade to follow.
SPIEGEL: What is your outlook for the US economy?
Krugman: If nothing happens, we'd have 11 percent or more unemployment by the end of 2009. Even with stimulus, 10 percent unemployment is possible. And it could well go on for years -- even the 2001 recession generated a 30-month employment slump. We need a huge stimulus in the United States -- intervention in the mortgage market to lower rates, plus 4 percent or more of gross domestic product in recovery measures.