On Sunday, I talked about about Wall Street's wild
week with two of the world's top economists. We discussed what the
market volatility means or doesn't mean, and what may lay behind it and
what lies ahead of us.
Paul Krugman won the 2008 Nobel Prize in Economics, and he is a columnist for The New York Times. Kenneth Rogoff
is a former chief economist at the International Monetary Fund, now a
professor of economics at Harvard University. Here's a lightly edited
transcript of our conversation:
Fareed Zakaria: Paul, let me start with you. The one
thing we saw over the week was markets up, markets down, but the one
trend that seemed persistent was there is a great demand for U.S.
treasuries despite the fact that the S&P downgraded it.
You've been talking a lot about this. Explain in your view what does
it mean that in moments like this U.S. treasuries are still in demand
and what that does is push interest rates even lower than they are.
Paul Krugman: Well, what it tells you is that the
investors, the market, are not at all afraid of what the policy elite or
people like Standard & Poor's are telling them they should be
afraid of.
You know, we've got all of Washington, all of Brussels, all of
Frankfurt saying debt, deficits, this is the big problem. And what we
actually have in reality is markets are terrified of prolonged
stagnation, maybe another recession. They still see U.S. government debt
as the safest thing out there, and are saying, if this was a reaction
of the S&P downgrade, it was the market's saying, "We're afraid that
that downgrade is going to lead to even more contractionary policy,
more austerity, pushing us deeper into the hole."
So it's a reality test, right? So we just had a wake-up call that
said, "Hey, you guys have been worrying about the entirely wrong things.
The really scary thing here is the prospect of what amounts toa
somewhat reduced version of the Great Depression in the Western world."
Fareed Zakaria: Ken Rogoff, worrying about the wrong thing?
Ken Rogoff: Well, I think the downgrade was well
justified. It's a very volatile world. And the reason there's still a
demand for treasuries is they've been downgraded a little bit to AA
plus. That looks pretty good compared to a lot of the other options
right now.
It's a very, very difficult time for investors. There is a financial
panic going on at some level. Some of it's adjusting to a lower growth
expectations, maybe a third of what we're seeing. Two-thirds of it is
the idea no one's home – not in Europe, not in the United States.
There's no leadership. And I really think that's what's driving the
panic.
Fareed Zakaria: But you wrote in an article of yours
that you think that this is part of actually a broader phenomenon which
is that people are realizing this is not a classic recession, this is
not a classic cyclical downturn. This is what you call a "Great Contraction". Explain what you mean by that.
Ken Rogoff: Well, recessions we have periodically
since World War II, but we haven't really had a financial crisis as
we're having now. And Carmen Reinhart and I think of this as a great
contraction, the second one, the first being the Great Depression, where
it's not just unemployment, it's not just output, but it's also credit,
housing and a lot of other things which are contracting. These things
last much longer because of the debt overhang that we started with.
After a typical recession, you come galloping out. Six months after it
ended, you're back to where you started. Another six or 12 months,
you're back to trend.
If you look at a contraction, one of these post-financial crisis
events, it can take up to four or five years just to get back to where
you started. So people are talking about a double dip, a second
recession. We never left the first one.
Fareed Zakaria: So, Paul Krugman, what the
implication of what Ken Rogoff is saying is spending large amounts of
money on stimulus programs is not going to be the answer because, until
the debt overhang works its way off, you're not going to get back to
trend growth. So, in that circumstance, you'll be wasting the money. Is
that – is -
Paul Krugman: No, that's not at all what it implies.
I think my analytical framework, the way I think about this, is not
very different from Ken's. At least I certainly believed from day one of
this slump that it was going to be something very different from one of
your standard V-shaped, down and up recessions, that it was going to
last a long time.
One of the things we can do, at least a partial answer, is in fact to
have institutions that are able to issue debt - namely the government -
do so and sustain spending and, among other things, by maintaining
employment, by maintaining income, you make it easier for the private
sector to work down that overhang of debt.
Fareed Zakaria: Ken, are you in favor of a – a second or a significant additional stimulus in the way that I think Paul Krugman is?
Ken Rogoff: No. I think that's where we part ways on
this. I think that creates a debt overhang in the terms of future taxes
that is not a magic bullet because it's not a typical recession. I do
think, if we used our credit to help facilitate one of these plans to
bring down the mortgage debt in this targeted way, and it could involve a
significant amount - that I would definitely consider. I mean, that's
how I would do it.
Now, obviously, things go from bad to worse, then you start taking
out more and more things from the toolkit, but I would start with
targeting the mortgages, then higher inflation, try to do some
structural reforms and, of course, if things are still going badly, I'm
open to more ideas.
Paul Krugman: I would say things have already gone
from bad to worse. I mean, this is a terrible, terrible situation out
there. You know, we talk about it, we look at GDP, whatever. We have
nine percent unemployment and, more to the point, we have long-term
unemployment at levels not seen since the Great Depression. Just an
incredibly large number of people trapped in basically permanent
unemployment.
This is something that desperately needs addressing. And I would be
saying we should not be trying one tool after another from the toolkit a
little bit at a time. At this point, we really want to be throwing
everything we can get mobilized at it.
I don't think fiscal stimulus is – is a magic bullet. I'm not sure
that inflation is a magic bullet in the sense that it's kind of hard to
get, unless you're doing a bunch of other things. So we should be trying
all of these things.
How did the Great Depression end? It ended, actually, of course,
with World War II, which was a massive fiscal expansion, but also
involved a substantial amount of inflation, which eroded the debt. What
we need - hopefully we don't need a world war to get there - but we need
this kind of all-out effort which we're not going to get.
Fareed Zakaria: You say World War II got us out of
the Depression. This was a massive stimulus, massive fiscal expansion.
But aren't we in a different world?
We are, right now, the United States with a budget deficit 10 percent
of GDP, which is the second highest in the industrial world. In two our
debt-to-GDP ratio goes to 100 percent. That strikes me as a situation,
which presumably has some upper limit. You can't just keep spending
money and incur these larger and larger debt loads.
Paul Krugman: I think those numbers are a bit high, about the debt levels a couple years out. It takes longer than that.
But the main thing to say is, look, think about the costs versus
benefits right now. Basically, the U.S. government can borrow money and
repay in constant dollars less than it borrowed. Are we really saying
that there are no projects that the federal government can undertake
that have an even slightly positive rate of return? Especially when you
bear in mind that many of the workers and resources that you employ on
those projects would be otherwise be unemployed.
The world wants to buy U.S. bonds. Let's supply some more, and let's
use those bonds to do something useful which might, among other things,
help to get us out of this terrible, terrible slump.
Ken Rogoff: Well, I think you have to be careful
about assuming that these low interest rates are going to last
indefinitely. They were very low for subprime mortgage borrowers a few
years ago. Interest rates can turn like the weather.
But I also question how much just untargeted stimulus would really
work. Infrastructure spending, if well spent, that's great. I'm all for
that. I'd borrow for that, assuming we're not paying Boston Big Dig kind
of prices for the infrastructure.
Fareed Zakaria: But, even if you were, wouldn't John
Maynard Keynes say that if you could employ people to dig a ditch and
then fill it up again, that's fine. They're being productively employed,
they pay taxes, so maybe the Boston's Big Dig was just fine after all?
Paul Krugman: Think about World War II, right? That
was actually negative for social product spending, and yet it brought us
out. I mean, partly because you want to put these things together, if
we say, "Look, we could use some inflation." Ken and I are both saying
that, which is of course anathema to a lot of people in Washington, but
is in fact what the basic logic says.
It's very hard to get inflation in a depressed economy. But if you
have a program of government spending plus an expansionary policy by the
Fed, you could get that. So if you think about using all of these
things together, you could accomplish a great deal.
If we discovered that space aliens were planning to attack and we
needed a massive buildup to counter the space alien threat - and really
inflation and budget deficits took secondary place to that - this slump
would be over in 18 months. And then if we discovered, oops, we made a
mistake there aren't actually any space aliens.
Ken Rogoff: So we need Orson Wells is what you're saying?
Paul Krugman: There was a Twilight Zone
episode like this, which scientists fake an alien threat in order to
achieve world peace. Well, this time we need it in order to get some
fiscal stimulus.
Fareed Zakaria: But Ken wouldn't agree with that, right? The space aliens wouldn't work -
Ken Rogoff: I think it's not so clear that Keynes
was right. I mean, there have been decades and decades of debate about
whether digging ditches is such a good idea.
And my read of the debate is when the government does really useful
things and spends the money in useful ways, it's a good idea. But when
it just dig ditches and fills them in, it's not productive and leaves
you with debt.
I don't think that's such a no-brainer. There are people going around
saying, "Oh, Keynes was right. Everything Keynes said was right." I
think this is a different animal, with this debt overhang that you need
to think about from the standard Keynesian framework.
Paul Krugman: I guess I just don't agree. I mean,
the debt overhang was an issue in the '30s, too - private sector debt
overhang. We came into this with higher public debt than I would have
liked, right? We're really, in some ways, paying the cost to the Bush
tax cuts and the Bush unfunded wars, which leave us with a higher
starting point of debt.
But the thing that drives me crazy about this debate, if I can say,
is that we have these hypothetical risks. All those hypothetical things
are leaving us doing nothing about the actual thing that's happening,
which is mass unemployment, mass waste of human resources, mass waste of
physical resources.
This is what's happening. We are hemorrhaging economic possibilities
and also destroying a lot of lives by letting this thing drift on. And
we're inventing these phantom threats (sometimes ghosts are real, I
guess) to keep us from acting.
Fareed Zakaria: Do you think that the lesson from
history, Ken, in terms of these kind of great contractions - we have not
had something like this since the 1930s, but there have been other
examples - tells you that until you get these debt levels down, no
matter what the government does, it's not going to get you back to
robust growth?
Ken Rogoff: I do, because what happens as you're
growing slowly, the debt problems start blowing up on you. That's
happening very dramatically in Europe. They had a philosophy and
approach of things are going to get much better - 'if we can just hang
on, we're going to grow really fast, the debt problems will go away.'
Well, guess what? They're not growing fast enough. The debt problems
are imploding. That's slowing growth, and it's a self- feeding cycle.
Paul Krugman: I guess I'm a little puzzled here
because, again, the thing that's holding us back right now in the United
States - although there are those peripheral European countries that
are having a very different kind of problem, partly because they don't
have their own currencies - but, in the United States, what's holding us
back is private sector debt. And, yes, we're not going to have a self
sustaining recovery unless that private sector debt could be brought
down.
Fareed Zakaria: Just to be clear, Paul, what you mean by that is individuals have a lot of debt on their balance sheets?
Paul Krugman: Yes, that's what's holding us back,
and we do need to bring that down - at least bring it down relative to
incomes. So what you need to do is you need to have policies to make
incomes grow.
That can include government spending, which is going to add to public
debt, but it's going to reduce the burden of private debt. It can
include inflationary policies, and it can include deliberate
forgiveness.
The idea that this has all faded, that we cannot do anything to grow
because we have to wait for some natural process to bring that debt
down, that doesn't follow from the analysis. There is a huge overhang of
debt, which is, at least as I see it, exactly the reason why we need
very activist government policies.
