Ten years ago in his book The Return of Depression Economics, Paul Krugman* warned of the problems that would lead to the current crisis. Last year the professor and trenchant columnist was awarded the Nobel Prize for Economics. In the interview below with Daniel Huber, Credit Suisse's Head of Publications, he talks of the reasons for the crisis, the lessons to be learned, and life as a winner of the Nobel Prize.
Daniel Huber: There are very few winners emerging from this crisis, but you seem to be one of them, because foreseeing this crisis a decade ago probably won you the Nobel Prize for Economics.
Paul Krugman: Well, I think I'm enough of a humanitarian to wish things hadn't turned out this way.
Would you consider yourself a pessimist or a realist?
In my view, it seems they're the same thing right now. But over the course of my career I have become focused on crises, as they have always interested me. I look at the current situation through this lens too. In other words, I'm more interested in a potential problem than the possible upside. I think I'm a realist, but with a pessimistic streak in the things I focus on.
Why did nobody listen when you first warned of an emerging global economic crisis 10 years ago?
First of all, the housing bubble helped to make things look good for quite a while. People were very reluctant to question that bubble for a variety of reasons. Part of it was just a general tendency to assume that the market must be right, while some of it was an unwillingness to quarrel with what looked like a successful model. When people are making lots of money, to tell them that their success is based on unsound foundations is not a popular thing. When you get through a crisis, as we did in the late nineties, the natural inclination is to pat yourself on the back and persuade yourself that it was your own wisdom and foresight that got you through it. But privately you say to yourself: Oh my God, that was a close miss.
Looking back, where do you see the major cause of the current economic crisis?
For me this is quite clearly the steady expansion of debt, particularly in the United States. But this is actually a trend that dates back around 25 years. The indicator I use most often is household debt relative to income, which had been stable for a generation until the beginning of the 1980s, when it began rising inexorably and eventually reached 100% of GDP on the eve of the crisis. However, this alarming development was even welcomed by many people, who saw it as a confirmation of markets functioning properly. But in retrospect you have to say that people were taking on much more than they could handle. It is worth nonetheless recalling some of the excesses of recent years in particular: The limitless granting of credit, the excesses in Eastern Europe, and other developments that have now come home to roost with a vengeance.
Have we already passed the nadir of the crisis?
Short-term economic forecasting is a bit like staring into a crystal ball. But nonetheless it appears that the pace of decline has now slowed, and that the worst of the crisis is over. You no longer have to brace yourself for yet more horrible news when you turn on your computer in the morning. There are still negative surprises, of course, but there are also now positive ones. Overall, it still does look like things are getting worse, but at a slower pace than before. That's an important step forward, but it doesn't mean that we can now say we're on the road to recovery. We have a long way to go before we reach that stage. The falling-off-the-cliff stage may have been stopped for now, but that doesn't mean that normal times are just around the corner. The current economic situation can be compared to a patient who has been rushed to the emergency room in critical condition and only just saved. Sure, we may have succeeded in warding off the Great Depression version 2.0, but that doesn't mean the patient is ready to leave the hospital. Quite the opposite: He's still very sick and we have no idea when he will recover.
Are they any examples from the past that could point a way out of the current crisis for us?
The answer to that is rather depressing, as there are no good historical role models for recovering from this kind of slump. The only appropriate example is Japan, which experienced a lost decade of economic stagnation, and then had a quite convincing recovery from 2003 onward on the back of a strong surge in exports. However, this recovery was almost exclusively driven by a growing trade surplus thanks to exports to China and the United States. This time the whole world is caught in a slump, so unless we can find another planet to absorb our global trade surplus, that's not a route out. Going back further, you have the historical precedent of the Great Depression, which was ended by a very large job creation program better known as World War II. Two observations can be made here with respect to the current crisis: First, that any program of any comparable size in the modern era would be impossible, except in the event of another major military conflict. Second, governments came into the last world war in relatively good economic shape in terms of their debt levels. So they had more leeway to pursue an expansive economic policy.
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Source: Credit Suisse - In Focus, July 21, 2009.
* Paul Krugman was born in New York on February 28, 1953. He is Professor of Economics at the University of Princeton, a highly respected columnist for the New York Times (on Mondays and Fridays), and the author of various works on economics. Last year he was awarded the Nobel Prize for Economics on the basis of his analysis of trading structures and centers of economic activity, according to the official wording of the Royal Swedish Academy of Sciences. In addition to his academic work, Krugman has continually been in demand as a consultant, including in 1982 on Ronald Reagan's Council of Economic Advisers, as well as a decade later during the presidential candidacy of Bill Clinton. He is believed to have declined an appointment to the White House following Clinton's victory, however.