Gross: Paul Krugman on America's Economic Crisis

This may be the winter of Paul Krugman's content. President Bush, whose economic policies the celebrated New York Times columnist has derided from the beginning, is leaving office. Krugman has been awarded the Nobel Prize in Economics. And Norton has just published The Return of Depression Economics and the Crisis of 2008, a substantial revision of the book he originally published in 1999. Krugman spoke with NEWSWEEK senior editor Daniel Gross.

NEWSWEEK: First thing, I want to get out of the way is what to call you. Is it Professor Krugman, Your Nobelness, Dr. Krugman, or—as you're known in the blogosphere—The Shrill One?
Paul Krugman: I'll go for the last one, or just "Hey, you."

When most people think of depression economics, they tend to think of the TVA and the Hoover Dam—elements of the New Deal. But that's not what you're talking about here.
What I mean by depression economics is a situation in which Uncle Alan [Greenspan] can't save us. In every recession—and we've had lots of recessions—the head of the Federal Reserve cuts interest rates, the recession ends and things come back. Depression economics is a situation in which normal anti-recession medicine no longer works. That was true in the 1930s, it was true of Japan in the 1990s, it was true in a lot of developing countries and now it's true for us.

You first wrote this book in the 1990s, when you were looking at crises in Mexico and Asia. Americans, being very U.S.-centric, looked at those cases and saw them as mere blips in this long peacetime expansion. Obviously, that narrative didn't strike a chord with you then. What did we miss?
Japan. That was the case that rattled me even before we had the high-speed crises in other Asian countries. And that's because Japan, once you get past the funny food and the bowing, is a country that's a lot like us. It's an advanced, sophisticated country with a stable government, and they found themselves trapped. That made me think, well, if it can happen to them, why couldn't it happen to us? Maybe we don't have this depression thing under control like we thought we did.

One of the things that comes out of these case studies is the matter of unpredictable consequences. When the authorities respond as they're "supposed" to respond, there are still frequently consequences that the model tells you aren't going to happen.
It turns out this modern world financial system contains all kinds of nasty potential linkages that were not in the models. We somehow missed that until it happened on a large scale in Asia.

So by letting Lehman Brothers fail, there's now a crisis in the money markets.
This crisis started with people buying condos they couldn't afford in Miami, and now that's producing a horrific economic crisis in the Baltic states. It's all linked together. Letting Lehman fail—letting the market work, as some people said—basically brought the entire world capital market down.

What was the problem with Greenspan, and where and when did he go wrong?
Greenspan is the real thing. He believes the Fed can be the designated driver, the one who takes you home safely after the party has gotten crazy. So he brushed aside any worries about regulating and taking precautionary measures. His belief in the perfection of free markets led us into the ditch we're in now.

How far does the comparison to the 1930s go?
I think in terms of functional analogies. We don't have dictators rising in central Europe or guys selling apples on the street—

—no, today they're selling iPods.
Or what claim to be iPods, anyway. But we do have a run on the banking system. Appearances are deceiving, because there weren't mobs in the streets outside buildings with FDIC insurance. Instead, it was mobs of people in cyberspace clicking on their mouses in a shadow banking system. So while it doesn't look like America during the Depression, we've got the same kind of underlying situation for economic policy.

I'm wondering what you think of Ben Bernanke at the Fed. He's a colleague of yours, a student of the Great Depression …
A student of Japan, also. One of the other people who found the Japanese experience deeply disturbing was Ben Bernanke, and he's thought a lot about how to not be like Japan. And he's tried. He's taken the Fed into unexplored territory. My wife jokes that next thing you know, they're going to start offering Federal Reserve Visa cards, because they're so far into the financial system. I can't think of anyone who could've done more or done better, but it still hasn't been enough.

And that's because of the magnitude of the crisis?
We basically had a $10 trillion shadow banking system shrivel up and die. Having the Fed add $700 billion to its balance sheet, or whatever it is by now, is not enough to make up for that.

One of the distressing things about this situation is how the problems have spread around the globe, even to countries not involved in our financial system. But in the last decade before this went down, there was a great deal of growth around the world. How much of that was part of the credit bubble?
Most of it was solid stuff. A lot of real growth was coming out of China, and that wasn't being driven by hedge funds. I think the point was not that the growth was phony, but that there was a lot of crazy risk taking. My mind is boggled that Hungary is in deep trouble because people were borrowing Swiss francs to buy houses. You think, what were they thinking? And yet you hear stories like that all over the world. So, it's not just the United States, but there was this widespread belief that bad things only happen to other people.

The panic of 1907 made people see the necessity of a federal banking system. What kind of institution is this crisis going to make us see the necessity of?
The basic principle is that anything that needs to be rescued like a bank needs to be regulated like a bank. If the likes of Lehman Brothers can bring the system down, then we need to have prudential regulations of them. The most obvious thing is capital requirements, which is basically limits on the degree of leverage. Authorities have to know what's going on if they're going to intervene in the situation.

Publishing lead times being what they are, the last bits of this were written a couple of months ago?
Less than that, actually. It was done in a frantic week in October, mostly.

You say in the book that the world economy is not in a depression and probably won't fall into a depression, though you're a little unsure on that. How has your level of certainty changed in the intervening weeks?
The last few weeks have been terrible. This was a book written after Lehman, so we knew the world was in big trouble, but what we've seen in the last couple of weeks has been awesomely bad. Things are falling fast. We're probably losing jobs at a rate of 350,000 to 400,000 a month. If you had asked me even three months ago about the chances we'd go above 10 percent unemployment, I'd have said pretty small, but now I'd say one in three.

I've written a column this week on who is the worst banker in the world. I'm wondering if you have any thoughts.
Just because he's easy to hate, I'd say Angelo Mozillo. Citigroup, also. They didn't have the worst behavior, but just because they're so big. When you have somebody that big doing things that bad, then it's way up there on the list. There's a lot of naked emperors out there these days.