Krugman: the full transcript
For those of a Keynesian persuasion, Paul Krugman’s visit to Britain this week is probably more exciting than the Diamond Jubilee and the Olympics put together. My interview with the economics Nobel laureate for the Indy can be found here. But for those of a wonkish nature who would like to hear Krugman’s views on recondite subjects such as NGDP targeting, the Phillips Curve and Glass Steagall, the full transcript is below.
The “Krug Man” (right) also explains why he thinks UK household debt levels are holding back the economy, why he suspects the IMF now regrets backing austerity and – perhaps most surprisingly of all – voices some sympathy for the German Chancellor, Angela Merkel.
Can Greece make it in the euro? Or is an exit now inevitable?
Something has to happen and in the end it does have to be a Greek exit. I’d be astonished if they can go more than two years. I’d be astonished if they could go even one year. It will become obvious, even if New Democracy [which backs austerity] is leading a new government within a couple of months it will obvious within a couple of months that nothing has changed. The forcing event is when the European Central Bank puts a stop to the emergency lending. Nobody wants to do that but at some point the numbers will make that unavoidable. There’s a bank “jog” going on [in Greek banks] – a slow exit. If I was a Greek depositor I’d be trying to shift money out because there’s a reasonable probability that after a long weekend you’ll find out that it has turned into a new drachma account worth 50 or 30 per cent of what the original one was. Of course there could be action forcing events elsewhere. Spain is looking pretty interesting this week.
Might Greece actually be better off out?
We don’t know. What you have is the uncertainty of stagnation and extreme depression conditions under current policies. With the Argentine example [which defaulted and broke its currency peg with the dollar in 2001] of a brief horrible period, followed by a strong recovery, the question is: is Greece really very different? A lot of what you hear about why Greece is different turns out not to be true. So Greece has almost no exports, but that’s only true of merchandise exports. The possibilities for a recovery are certainly there. One of the major exports is of course tourism. A chaotic political scene is not of course good. It’s crude and terribly unfair as a caricature, but the image is: Greece exits, there’s horrible confusion, the banks are disrupted, and it’s a very ugly scene for six months or a year, but after that there’s tons of package tours of British lager louts going to the Greek isles, right? It doesn’t matter, they’re bringing currency! It sounds awful, but compared with 50 per cent youth unemployment, maybe not so bad.
But Argentina benefited from a commodity export boom. Greece is going to be faced with a still depressed European economy if it exits..
I go with Mike Weisbrot at the American Center for Economic and Policy Research who says that the commodity export thing is way overstated in the Argentine case. Actually on the eve of Argentine devaluation, their exports as a share of GDP were only about half as large as Greece’s are now. That’s one of the things that people say are wrong. [But] it’s not really clear. Service exports… we don’t know how much difference that makes. There’s no certainty. Anyone says I’m highly confident Greece would do as well in the three years following devaluation – I don’t know that. But it’s not as if Greece is on a sustainable path and this would at least offer the possibility.
How do you think a Greek exit would effect the British economy?
Greece essentially doesn’t matter except in terms of the knock-on effects on the Eurozone. If Greece exits then we know that the euro [membership] turns out to be non irreversible. You then do have a run on Spanish and Italian banks that does not lead to an immediate crisis so long as the ECB is willing to supply the euros. But that does lead to a big increase in the ECB balance sheet, which also raises the question: where is the hope for recovery for those countries. So they have some time if they’re willing to lend lots of money. It doesn’t lead to an immediate collapse if they’re willing to lend essentially unlimited amounts. But that’s also an unsustainable situation unless there’s a change in policy that gives a reasonable hope of a recovery in a five year period. There’s a fork in the road: open ECB lending plus more expansionary [fiscal policy] and a higher inflation targeting. Or a complete Eurozone break up. Both alternatives sound impossible but one of them has to happen. What will Germany in the end be? It’s not Sophie’s Choice, but Germany’s choice. Maybe in the end they will accept the need for some unorthodoxy to save the euro, and then I read Jens Weidmann [the hardline head of the Bundesbank] yesterday and then I say: maybe not.
Do you think that Spain and Italy are in a fundamentally different place than Greece in terms of their ability to stay in the single currency? Or does the logic dictate they should go as well?
They’re both in fundamentally stronger positions than Greece, although still terrible. Spain still has relatively low levels of public debt. It’s not like the Greece situation where you come in with absolutely insane levels of public debt. Their situation looks more workable if they can have a reasonable hope of achieving the real devaluation they need. Italy has high levels of public debt, but relatively low levels of fiscal deficit. They also have much more moral leverage. The Greeks were genuinely irresponsible and dishonest in a way that neither Spain nor Italy was.
If you had to assign blame for the entire Eurozone crisis, who would be in the dock?
I think that the die was cast, the whole thing was pretty much fated, from the moment the Maastricht Treaty was signed [in 1992]. It was practically the entire European elite that wanted that. There’s no one person who said: “full speed ahead let’s do this”. Maybe the original sin goes all the way back to the coal and steel community somehow. It was something that kind of had to happen. Clearly some people have been giving bad advice along the way.
Does that give you some sympathy with Angela Merkel and other euro politicians who have been forced to deal with this fated crisis?
Yeah, I actually don’t particularly personalise it as being Merkel’s….She is not a model of clarity and forcefulness. But even if she were – then what? She’d have to bring the German electorate with her. The whole Eurozone concept was deeply flawed from the get go. The crucial error were made in the late 1980s when this project gelled. It’s the ineluctable logic of tragedy.
One criticism of Merkel is that she hasn’t spelled out to the German people that they face a clear choice: underwrite the euro or see it break up…
That can go more broadly. The whole collection of euro leadership has been to deny the harshness of the choices – the whole expansionary austerity mania was essentially wishful thinking posing as wisdom. Merkel in an ideal world would have – I don’t know what the German equivalent would be – held a national conference and say whatever the German version of “teachable moment” is. But that’s asking rather a lot and it’s not clear it would have worked even if she had.
David Cameron says austerity vs growth is a false choice. Is he right?
There is a choice. You could have a policy which is austerity later but expansion now, but that’s not what he’s saying. No, If the Government is going to join in the deleveraging – if we’re going to a mutually destructive vicious circle of deleveraging going on – and if the government instead of acting as the counterbalance to that is going to join in the process, that’s going to harm the economy. The notion that you can somehow fudge that is wishful thinking.
Labour’s big idea is a VAT cut. But a lot of academic economists say that infrastructure and construction should be a bigger priority because it has a higher fiscal multiplier. I know you’re in favour of construction spending, but would you be averse to temporary tax cuts aswell?
I think it’s better than not. There is always the fact that temporary tax cuts may be ineffective because they’ll be saved. A VAT cut is a little bit funny because it also in effect creates the expectation of future inflation so it might be more effective. It’s a second best. I haven’t scoped out the political ramifications sufficiently here. Last fall Obama pushed for extended payroll tax cuts, which would definitely not what I would have wanted by way of stimulus, but I was supportive of it anyway because it was something. And in any case it was more of a way of laying down a marker. So maybe that’s ok here. The coalition plans do call for these really dramatic cuts in public investment – that almost certainly isn’t a good idea.
Britain’s national debt is not high compared to when we came out of the Second World War. But it is high for peacetime. Does that give you pause?
It should have been paid down more. I think there is a fair charge that the Blair/Brown years were not wildly – not Greek level – fiscally irresponsible, but that they didn’t use the prosperity well. It’s not a war, but it is the worst financial/economic crisis since the 30s. It’s not as if we – in the UK or the US – are running these deficits on a whim. They are appropriate given the situation. This is a pretty reasonable excuse for running deficits. This is not one of those things where you can say, this is will set the pattern of behaviour forever. That’s not true. All the evidence has been that the politicians are way too eager to reduce the deficit, rather than way too slow. The idea that they will continue to do deeply irresponsible budgeting even after the economy recovers is wrong.
Household debt is very high in the UK. Is that also weighing on the economy?
It almost certainly has to be. In the US we have quite a lot of empirical work that says household debt is the major factor behind our weakness. Presumably the same must be true here, although I’m not aware of comparable work here. The best going story in the US is an excessive household debt story.
Ben Broadbent of the Monetary Policy Committee says we never had a US-style housing bust in the Britain so the UK’s household levels of debt are not excessive since they are matched by assets that have retained their value…
I guess it’s still unclear. They question would be whether household still feel the need to deleverage even with the high housing prices. It’s true that the enormous hit to household net worth hasn’t happened here, but I’d still be surprised if it’s not an important factor. The problems of the financial industry weigh even more heavily here, if only because the City and Wall Street are comparable size entities but here it’s living in a much smaller economy, so here it might be a bigger deal. The general story that seems to fit together for a lot of the advanced world is one of excessive household leverage and then payback.
Could you see any argument that Britain might have been a bitter off if we’d been inside the Eurozone?
Wow! I suppose there’s always some argument people could make, but my God! Cameron and Osborne love to claim credit for those low borrowing costs, but in fact those seem to be overwhelmingly the result of not being in the euro. Even now – with everything going on – Spain’s fiscal prospects look no worse and maybe better than Britain’s and yet bond yields are 6.6% there and now 1.6% here. I actually think they ought to put up statue to Gordon Brown in Trafalgar Square to thank him for keeping Britain out of the euro. It would have been an utter disaster if Britain had joined.
On Gordon Brown, he had a slip of the tongue in 2008, when he said he “saved the world” when he pioneered the bank recap. But is that actually fair?
I think it’s arguably right. We now look back in those 6 months after Lehman failed. Policymakers did the right things. There should have been more strings attached etc and they punted thereafter. But they did do what was necessary to stop a complete financial collapse. We now talk as if that was fated to happen. Maybe not! Clearly it was Gordon Brown who moved first in doing that. Without that maybe the people who thought it was great idea to let Lehman fail to eliminate moral hazard might have continued to carry the argument for another couple of months, by which time it might have been irreversible.
Gordon Brown was blocked from heading the IMF by George Osborne. Do you think that the IMF would have benefited by being led by someone with a very clear grasp of macro economics?
It might have. It would have been interesting and probably good to have a director general who really knew macro for himself. But as it’s working out Christine Lagarde is now working very closely with my old colleague Olivier Blanchard [IMF chief economist]. So it’s not as if the IMF is lacking macroeconomic clarity. So it’s working out ok I think.
But Lagarde is still pulling her punches though. You read between the lines of the recent IMF mission statement and it’s asking for a Plan B. But she came to London and said that George Osborne’s course is the right one. Isn’t it a problem if the IMF can’t say what it really thinks?
But would that have been any better if it were Gordon Brown doing in to do this? That would have been deeply awkward. No; that’s the problem: when they deal with a major country that does not need an adjustment programme, there is only so much they can do and say. On top of that the fact that the Fund did rather strongly endorse the original programme which was foolish then. Although I’m reasonably sure that the staff are all convinced now that that was an utter disaster, they can’t quite say that. I guess the question is: what does the British public make of all this? Was anyone under any illusions about what that Article IV [the IMF’s UK report document] actually said?
There are a lot of eminent economists who have got a lot of things wrong. For the lay person it’s hard to trust the profession now. Is that scepticism a good thing? Or have some people poisoned the well?
I guess I would be more disturbed by it if my colleagues had actually demonstrated that they deserve the trust! There is not licence requirement. So some of the people who made very confident but totally wrong pronouncements are not trained economists…But actually that’s not much of an issue because a lot of people who ARE highly credentialed got it totally wrong. What can you say? If Allan Meltzer whose been heading the Shadow Open Market Committee all these years is going to come out in 2009 and predict runaway inflation from the expansion of the Fed balance sheet and show absolutely no reduction in his self confidence three years later and the runaway inflation is showing absolutely no sign of materialising then the public shouldn’t trust economists. They should trust me!
Should there be a greater recognition from the public that economists isn’t a science, that there’s inevitably a big dose of politics and ideology involved?
I’m not sure about inevitably. I think we’ve retrogressed. I think 40 years ago the profession would have responded better, that this poisoning of our discourse by ideology and politics has reached into the economic profession. Something has gone terribly wrong. It’s not as if the doctrines were working great and that failed in this crisis. A large part of the freshwater economics project [the neoliberal Chicago school] had failed visibly as an empirical matter 30 years ago and yet continued to expand its hold on the profession. I’m not sure that it’s inherently the case that economics can’t be more scientific, but it’s certainly has not turned that way.
Could it be heading that way?
Within macro lots of really fine empirical work is now going on. In the 1980s when I was in my 30s we already had this trench warfare within macroeconomics. It was already a minefield to get into the core issues. So if you wanted to be sensible what you did was wrote papers that were centred on something else and only tangentially touched the core business cycle issues. Now there’s a different way, which is to do lots of nitty gritty empirical work. And that stuff has been really lovely, and maybe that’s our salvation. I look at people who are doing macro now who are in their early 20s and 30s, and think twenty years from we’ll have a much better profession. Essentially nobody has admitted they were wrong. But it’s the old line: “science progresses funeral by funeral”.
On the fiscal vs monetary policy debate, there’s a lot of pressure on the Bank of England to do more money printing. Do you think the evidence is there to say that if you do X amount you get X amount of return, so that’s what we should do?
The evidence is really thin. The evidence that just expanding the central bank balance sheet or even expanding it into uncoventional assets has a big effect on the economy is pretty thin. It’s very iffy, it’s weak, there’s probably something there, but it’s not something you really want to count on – which doesn’t mean don’t do it, but it’s not a guaranteed solution. What you do seem to see is that when major QE programmes are announced there’s a pretty big effect on expectations, especially inflation expectations, which is, after all what, in simple models, the way you get leverage in this kind of situation. You can see when the fed began its QE2 programme, there’s not that much evidence of a significant change in the term structure of interest rates, but inflation expectations had plunged and they bounced back. QE serves a signal that perhaps the central bank won’t be so keen to pull the trigger and start raising rates. It’s not working through its ostensible channel of influence, but through the expectations channel. But again – you take what you can get. I still think the prudent policy would be to rely on fiscal stimulus as the primary tool, but backed up by monetary. And if you can’t get the fiscal stimulus by all means let’s do the QE and cross our fingers.
What about Nominal GDP targeting? Would you support a change in the Bank’s mandate?
I have a possibly minor worry that in the longer run that if you do have an NGDP target, what if you have an acceleration of the rate of potential output growth? That’s automatically lowering your implicit inflation target. Do you really want to do that? So it’s not clear that that’s a good long run framework. The argument that people are using for it now is that it’s a way of creating that credible commitment to future inflation without actually saying so in so many words. I guess my thought would be that if you think that’s going to fool anybody – if you think you can slide that past [hard money/libertarian US Senator] Ron Paul – you’re kidding yourself. I don’t have a strong feeling about NGDP one way or the other – I think the idea that it’s a magic bullet is wrong, but if that helps sell more aggressive monetary policy, sure.
What about simply raising the Bank of England’s policy rate?
I’m all for that. The micro costs of 4% instead of 2% inflation are as far as we can tell trivial. We had 4% inflation during Ronald Reagan’s second term and it did not seem like a big problem. Where did the 2 per cent norm come from? People weren’t aware of the zero lower bound problem [where rates can’t go any lower and the economy still needs stimulus]. And there were a number of studies that were done by the fed and elsewhere in 2001/2002 suggesting that as long as you had a 2% target it was extremely unlikely that you’d find yourself up against the zero lower bound. We just learned about that. It now turns out that 4% makes a lot more sense. It now makes sense as a prospective thing, since it would at least somewhat raise expectations of inflation and then as a deeper cushion against the kind of mess we’re in now in the longer run – I’ve been pushing that line since 1998. But it’s one of those things that we have a situation in which the wild and crazy people are the ones who believe in standard textbook economics and the sensible people are the ones who invent all these reasons why you shouldn’t do what the textbook says you should do.
And should the Bank of England should have an employment mandate like the Federal Reserve?
The idea [took hold] that stable inflation rate means that you’re also going to be at sustainable full employment, which relies on the belief that the long-run Phillips Curve is vertical. We’re now getting very strong evidence that it’s not – that you can have stable inflation with persistently depressed employment. I worry that we may get into a position where central banks say “well inflation is stable, we’ve done our job” when the economy is in fact sitting far, far below capacity.
What about the private banks? Should they be split up completely, rather than merely “ringfenced” as the Government is doing?
I haven’t looked at the UK reforms. Restoring Glass-Steagall [which split up US banks after the Great Depression] – there’s a lot to be said for doing that. But if you believe that doing that, or breaking up the too big to fail banks is a sufficient condition for stability you’re wrong. Lehman Brothers would have been unaffected by Glass-Steagall because they were doing shadow banking. They weren’t that big either. If you go back to 1930s it was actually the cascading failure of small banks that brought the thing down. If your basic model is Diamond-Dybvig which is a multiple equilibrium, possibilities of bank runs, that tells you two things – there’s nothing special really about deposits. Anything that borrows short and lends long is illiquid, so shadow banking is every bit as dangerous as depository banking. And it also tells you that an economy of many small banks is also subject to these things. There are a lot of reasons to be worried about Too Big to Fail – there’s the political economy issues, moral hazard issues. But breaking up the banks both by function and size diminishes your problem, but doesn’t solve it. If we can reproduce the functional equivalent of the banking regulation system we had for half a century after the 30s – that worked! Name a financial innovation of the past 30 years that has been clearly, unambiguously beneficial other than ATMs. Nobody has been able to answer that.Tagged in: Glass Steagall, inflation, Paul Krugman NGDP, Phillips Curve, stimulus
Latest from Independent journalists on Twitter