[MUSIC PLAYING] WU: Well, hello, everyone. Thank you for coming. I know it's been
hard to get in today. We want to welcome
you to the spring lecturer of the Undergraduate
Economics Association. I'm Charles Wu, the president. PATTY: I'm Manisha Patty. I'm the vice president. Sorry for running in. Let me now present the head
of the economics department, Ricardo Caballero, to introduce
our distinguished lecturer today. [APPLAUSE] CABALLERO: Thank you. And welcome, you all, to this
very, very special event put together by Teresa, Sarah,
and the Economics Undergrad's Association. It's certainly a great honor to
introduce to you Paul Krugman. Thank you very much,
Paul, for being here. We know that your time is
quite scare these days. I think the reason,
though, he came is because Paul is
truly an MIT guy. He did his PhD here. He has been a member of
the faculty more than once. And who knows what
the future brings, no? But he clearly is
part of our community. And so I thank you very much. You make us very proud, Paul. Many of you may know
Paul for his very insightful and entertaining
opinion columns in New York Times and
many other venues. Some of us, however,
have the privilege of knowing the other part
of Paul, his academic side. And I grew up learning
from Paul's papers. And we never had
any doubt that he would receive the Nobel Prize. The question was when. And we're delighted that it
already happened in 2008. And again, this was the
last of a long sequence of all the possible awards
you can get in economics. And it's pretty easy for the
insiders, for the economists, to understand why
he got these prizes. Not only does he have
seminal contributions in international trade
and international finance, but also reading an
academic paper by Paul, as it is to read in a column
actually, it's a delight. Paul has probably the
largest ratio of insight to mathematics that you can
find in academic papers. And I think the main
reason that's the case is that he has superb
economic intuition. Truly outstanding. I would compare it to that
of our late and great Paul Samuelson. These are people that can really
use math to communicate ideas. But they have seen what
they want to say well before they saw the equations. That's pretty unique. In fact, I'm not sure
I should say this, but when I was a student
here in our graduate program, we used to joke with
some of my classmates that many of Paul's papers had
mathematical errors in them. But they always came in pairs. And they offset each
other, so the conclusions were always right. And that's how good
his intuition is. In any event, it's a great
honor to have you with us, Paul. Welcome. [APPLAUSE] KRUGMAN: So Ricardo
kind of trumped my response, which was,
the real reason that I have such a high ratio of other
stuff to math in my papers is, I'm actually a quite
lousy mathematician. But OK. So I'm going to try
and talk not too long, because my general
impression on these things is that the back and
forth is a lot more interesting than the lecture. As the title of
the talk implies, I really want to talk some
about the state we're in, but also some about the
intellectual state we're in. Where are we now? And how could this happen? Have we actually learned
anything from it? And so on. So when I try and think
about the mess we're in, I often find myself going
back to an incident that happened back in 2002. I wasn't there, but
I've read about it. There was a conference
at the Federal Reserve to honor Milton Friedman
on his 90th birthday. And at that conference,
Ben Bernanke, who had recently
moved to the Fed from teaching at some school
or other in New Jersey, addressed Milton Friedman
and Schwartz in reference to Friedman's famous work on the
errors of the Federal Reserve, which, according to Friedman,
was the reason that the Great Depression happened. If the Fed had only done its
job, it wouldn't have happened. Ben Bernanke said, on behalf
of the Federal Reserve, I'd like to say to
you, yes, you're right. We did it. We're very sorry. But thanks to you, it
won't happen again. Six years later,
it happened again. And so the question I
want to ask is, how is it that we got into
something that bears such a distinct resemblance
to the Great Depression? What were the mistakes,
and what have we learned? Are we actually continuing to
make some of the old mistakes? What's going on here? I guess, at some
level, the question is, what are economists good for? But in any case, the question
is, how did all this happen? So let me talk first about
what it is we thought we knew. What we thought we knew was
that the Great Depression was possible first and
foremost because we had an unprotected banking
system combined with a Federal Reserve, a monetary authority,
that didn't understand what needed to be done. And so there was a recession. There was a stock
market boom and bust. And there would have been
a recession regardless. But what made the Great
Depression so great was banking collapse. There was a loss of confidence. People pulled money
out of the banks. It led to a collapse of the
financial system, panic, disruption of markets. The Federal Reserve
failed to act forcefully. It failed to supply liquidity. It failed to rescue banks
that were in trouble. It failed to prevent a sharp
fall in the money supply. Although there's
a real question, I think, given what's happened
right now, whether they really could have. But certainly, the
story as Milton Friedman told it was that, if only the
Fed had done what it should have, there wouldn't have been
a shortfall of money supply and there wouldn't have
been a Great Depression. And then, going on from
there, the argument is that governments
didn't understand what needed to be done. They didn't act on it. They did some mild what we would
now call Keynesian programs. But they were never
remotely big enough, as, actually, a former
department at MIT, E. Cary Brown, famously showed,
that once you adjust for cyclical effects
on the budget, there really never was
very much fiscal expansion during the '30s. That fiscal policy didn't work
because it was never tried. And to the extent that
there was fiscal policy, it was halfhearted. It was pulled back. There was the famous
mistake of 1937, when FDR was convinced
that the recovery was solid and no longer needed all that
support from the government. The Federal Reserve,
similarly convinced, tried to mop up some of those
excess reserves in the banking system. And the result was a severe
recession, the Second Great Depression, as many people
called it at the time-- all of these mistakes
that came from the past. And since we knew
about all that, it wasn't going to happen again. We had banks which were
protected by deposit insurance, so as to rule out bank runs. We had regulation of banks to
go along with the insurance. We had monetary authorities
who understood the risks and would not make the
same mistakes that banks made in the '30s. Altogether, we had
learned the lessons. We were in a position not
to make those same mistakes all over again. At the very least,
we would understand that you don't allow a
plunge in the money supply. So this wasn't supposed
to be possible again. And then came our
current crisis. What do we understand
now about the crisis? What we understand, I
think, is that we ended up having something that was
a teched up 21st century version of what happened in
1930, that it was very much a replay of the same
kinds of events. Now, things look different. Because bank
deposits are insured, we did not have bank runs in
the form of mobs of people out in the street pounding
on the doors of closed bank buildings. But we had the economic
equivalent of bank runs, with people rushing to
pull short-term funds out of institutions that really
were not in a position to repay those funds on short notice. So we had a financial collapse. By some measures, the
financial disruption that took place in
2008 was as bad as what happened in 1930, 1931. We had a monstrous bubble in
housing and in real estate more generally coming into this,
which looked every bit as crazy, in retrospect, as the
stock market boom of the '20s. What's really weird
is that we managed to have that giant bubble
just a couple of years after our own
giant stock bubble. But nonetheless, we had that,
which depressed the economy and created what would surely
have been a serious recession, even if the financial system
hadn't gone completely bust-- but on top of
that, the major collapse of the financial system. Well, all in all, it looked
a whole lot like the slump in at the beginning of the '30s. You can read John Maynard
Keynes's great essay. This is six years
before he published "The General Theory of
Employment, Interest, and Money." He wrote an essay called
"The Great Slump of 1930." And you really
only have to change a few words to make
it sound like it's a description of recent events. It was something that was
very, very similar in its form, not like the great
recessions of '74, '75, or of the early 1980s,
which were driven, at least to a large extent, by
external events by disruption of oil supply. This was a purely
internal malfunction. It was, as Keynes wrote in
1930, magneto trouble, which turns out to be actually-- I thought it was
alternator, but it's more like the early version
of a spark plug or something. But anyway, a small
part in the car malfunctioned but it brought
the whole engine to a stop. And we did it all over again. How is that possible? A part of the
answer is that we-- actually, let me say it
a little differently. What I say is that we had a
combination of mislearning the lessons of the
Great Depression, forgetting the lessons,
and failing to generalize-- excessive literal-mindedness. So let me go through
those in some sequence. In terms of mislearning,
we developed a conviction that the Federal Reserve
or its counterparts abroad can always do whatever
is necessary to stop a slump. The interpretation, not at the
time, but some years later, by the time that Milton
Friedman was in his heyday, was that people had
become convinced that, if only the Federal
Reserve had been more aggressive, that
would easily have prevented the Great Depression. And since we had smarter, better
central bankers these days, we were never going to
experience that again. Even before this
hit, if you were looking at events outside
the United States, you realized that that was
probably a misinterpretation, that, yes, the Fed can
always print lots of money. But if short-term
interest rates go to zero, further money printing
doesn't do anything. It has no traction. It's not clear. When Friedman and
Schwartz showed that there was a big
decline the money supply, they used a broad
measure of money, which was a variety of
deposits, as well as just currency and bank reserves. And it was just presumed that
the Fed could have stopped that from falling. It's not at all clear
that it could have. And we could see
that in a way now, where there's vast amounts
of bank reserves out there which are not being lent out. And so we probably
mislearned some of the lessons of the 1930s. There was an unwarranted
belief that it was easy for
technical operations by the Federal Reserve
to prevent this crisis. We forgot some of the lessons. I think people simply
forgot just how unstable financial
markets can be. They forgot how difficult it can
be to get policy traction when things are really bad. It's another example
of reading old stuff. You can acquire a newly printed
edition of the 1948 edition of Paul Samuelson's
economics textbook. And it's really
interesting reading. And particularly, if
you read the sections about the limits of monetary
policy in fighting slumps, it sounds exactly right. It sounds exactly like what
we're going through right now. So Samuelson in 1948 had
a really good appreciation of the limits of policy. But we forgot that. By the time I started writing
a principles of economics textbook, all of those
caveats, all of those cautions were gone, and the
general view was of the omnipotence
of central banks, at least in their
ability to create demand. And so we forgot lessons. We forgot stuff
that we had known. I'll be talking more
about that forgetting in a few more minutes. And literalness-- we
did know that banks are subject to bank
runs, although we forgot just how serious. There was a big
move to deregulate banks, which was based on
forgetting just how badly they'd gone awry in the past. But mainly, what happened was-- and I'm guilty of this too--
you looked out there and said, well, but we have
deposit insurance. We have guarantees. We have credit lines
from the Federal Reserve. Banks can go bad,
but we can't have the kinds of destructive bank
runs, the kind of disruptive failure of the banking system
that we had in the 1930s, because we do have institutions
to protect against that. The trouble was, of course-- now it's "of
course--" that we were excessively literal in our idea
of what it is to be a bank. We thought of a bank as
being, well, basically, a big marble building with a
row of tellers and Jimmy Stewart running it, whereas,
in fact, of course, we should have known better. Even in your basic economic
models of bank runs, the bank that appears
in those models is not defined by
those characteristics. The bank is defined by borrowing
short and lending long, by creating liquid assets
that people can regard as money, while, at the
same time, using the money placed in their care
to make investments that can't be turned into
cash on short notice. And by that standard,
lots of things are banks. These days now, everybody
talks about the shadow banking system, all of the institutions
that were effectively banks but were not-- depository institutions. Until the crisis hit, no one
was thinking much about that. And so we were
caught by surprise. It turned out that you
could have bank runs just like the old ones except
not quite so visible because we had all of these
things that were banks, but not banks in the
old sense, and subject to the same kind of
collapse of confidence. So instead of mobs of
people in the street, you had mobs of
investors refusing to roll over their repos. But the effects were the same. And so we were
caught by surprise by this terrifying crisis. The actual slump has not been
as bad as the Great Depression. And there's been some
self-congratulation about that, probably excessive. I'm not sure. I have extremely high regard for
my former department chairman. But I'm not sure that "the
world didn't end on his watch" is a good enough reason to make
Ben Bernanke man of the year. But things have been
not as bad as they were in the Great Depression. And that is an achievement. If we look at the first
year, globally, of the slump, it actually was comparable
to the Great Depression. Industrial production
in the first 12 months will tell us as much
this time around as it did from '29 to '30. World Trade fell
faster than it did in the first year of
the Great Depression, but then it did level off. So what it looks like is
that the shock to the system was every bit as bad as it
was in the Great Depression, but the system handled it
better this time around. Why was that? Well, part of the answer was,
we have learned some things, although there were
some obvious failures to understand the
depth of the problem. The failure to rescue Lehman was
obviously a huge misjudgment, sort of the 21st century
equivalent of the failure to rescue the Bank of the
United States in 1930. Nonetheless, there
was willingness to step in and rescue key
financial institutions. People stepped in to protect the
system from a total meltdown. And that certainly helped. I suspect that a very large part
of the reason we didn't have a full replay of the
Great Depression, though, is actually not that. Although I wouldn't want to try
the experiment of letting more financial institutions
go back and do it again and let even more stuff fail and
not bail out AIG and all that. Probably a very large part of
what went right, or at least didn't go as wrong as
it might have this time, was simply the fact that we
have much bigger governments than we did 80 years ago. That's an underappreciated
aspect of the story. Big government in the crisis has
been a help almost independent of what the governments do,
because at least they're there, so that when
production is falling, and private sector
employment is falling, and people are nervous,
and nobody wants to spend, the social security
checks are still going out Medicare is still
paying the health care bills. There's just a large
automatic stabilizer role of government, which has almost
surely been a major factor in cushioning the crisis. If we hadn't had that,
it could quite easily have been a much,
much deeper slump. And then there have been some
deliberate government efforts to prop up demand. Yes, we have a stimulus. Yes, we would probably
have 12% unemployment now if we hadn't had the
stimulus in the United States. But the efforts
to prop up demand have been, on the whole,
probably a smaller factor in what's gone right
than the simple existence of big government and
the moves to stabilize the financial sector. Still, I don't think you should
want to view this as a success story, even so far. What we did was,
despite everything we were supposed to
have learned, we managed to do something that was
at least a pretty significant echo of the Great Depression. Maybe it wasn't the
same total collapse. Unemployment wasn't
quite so bad. I was about to say there
aren't people selling apples on the street. But actually, there
are a lot of people selling whatever on the street. I don't, obviously,
personally, have any memories of New York in the '30s. But in New York in early
2010 looks pretty bad. It's been a quite serious
devastation to the economy. It's not supposed
to have happened. Furthermore, this
thing ain't over. One of the difficult
things, I think, that people have in
wrapping their minds around is that the end of a recession
is not the end of the slump, that, while it's
almost certainly true that the National Bureau
of Economic Research will eventually declare
that the recession ended in June or July of
2009, unemployment has continued to rise-- yes, it was down
slightly this morning, but that's statistical
noise, almost surely-- and that most of us
do not think that it's going to come down
quickly at all, that we're likely to be facing
probably years of high unemployment, which
is years of huge suffering in the population, years
that will leave really long-term scars on our society. The line I was about to
use-- well, I'll use it-- is the worst hit, probably,
in terms of lifetime impact, are young people
graduating from college facing a terrible job market. And what the statistical
estimates show is that, basically, if you graduate
into a bad job market, you will still be worse off than
if you graduate into a good job market even 20 years later. So there will be
really long-term damage from all of this. Sorry about that, guys. So everyone leave the room
and go polish up your resumes. Something else is
happening again too. I think we're now past the
point of saying, oh, my god, how did we manage to
reproduce the situation that led to the great crash of 1930? But ever since the GDP
seemed to stabilize, the economy seemed
to end its freefall. Now, everyone has
been saying, well, the thing now is to
make sure we don't repeat the mistakes that were
made later during the Great Depression. Don't repeat the mistake
of pulling out the support from the economy when
the recovery really wasn't solidly in place
and sending the economy into a second slump. So we're not going
to do 1937 again. Everyone says that, lots
of people on the outside. Christy Romer, the head of the
Council of Economic Advisors, has even published an article,
"The Lessons of 1937," explaining why we really
don't want to do that. The fact is, at
least at the moment, it appears that we
are going to do that. It's almost baked
in at this point. The stimulus reaches
its peak impact on the economy, as best
we can tell, this summer, and then starts to fade out. All indications are
that unemployment will remain very high. The economy is going to
be still deep in the hole. The Federal Reserve is going to
come to an end of its mortgage purchase program, which
is one of the main things that it's been doing beyond
just keeping interest rates low. Again, that's going to
happen in a few months. The economy is still
deep in the hole. If you look at the budget that
the administration offered last wee-- this week-- I'm losing my track of time. Anyway, when you
look at the budget, it actually predicts or calls
for substantial cutbacks in government spending, mainly
as a result of the expiration of the fading out
of the stimulus, but also because
there's now to be a freeze on nonsecurity
discretionary spending, which is to appease the deficit hawks. All of that adds up to a
pretty significant turn towards contractionary policy
taking place over the next year or so in the face of a
deeply depressed economy. Will that actually send us
into a double dip recession? I think the technical
answer is, God knows. There's so much going
on in the economy, it's never possible
to really know. But we do know,
anyway, that policy is acting as if the problem
has been just about solved, whereas the reality is,
mass unemployment is a likely feature of the economy
for quite some time to come. What I think we really
failed to learn, or certainly, at
least in policy, we're not responding to,
is that, historically, the aftermath of
financial crises is a very, very prolonged
period of high unemployment, that it's not something
you solve just by stepping in and preventing
the freefall of the economy. It's something that is going
to require a lot of action to support the economy
for an extended period. Anybody who is interested
in these things should look at the work of
Carmen Reinhart and Ken Rogoff, who have studied past financial
crises and produced summary statistics. What Rogoff says is that we are
actually experiencing a garden variety severe financial
crisis, which sounds oxymoronic. But what he means by that
is that the United States is more or less so far tracking
right down the average. Take a severe financial crisis. The United States is looking
just like the average. And in the average
financial crisis, unemployment rises
for almost five years before it starts turning down. So we are looking at a
really prolonged period of high unemployment if
history is any guide. And yet we are actually starting
to withdraw policy support from the economy quite soon. So what's going on? How can we be replaying
the past so badly. That's really the question
that has worried me a lot. Part of the answer is politics. Obviously, I think we've all
learned a pretty harsh lesson in all of this. We've learned that, if
you're an economist, you tend to say,
well, let's figure out what the optimal
policy is, and the job is done once you've
explained what that is. In reality, of
course, things have to go through a
legislative process. It can be very
difficult to do things, even if you're quite
sure they should be done, because other
people don't agree, or other people actually
even might privately believe they should be done, but
not with the other guy sitting in the White House. So there's a real difficulty
in getting things through. There's a lot of
difficulty also in getting what you do understand
economically past even sympathetic politicians. A year ago, there
was always a lot of discussion, discussion
among the people who were actually going
to make the policy bill-- so discussion kibitzing from
the outside and some meetings and phone conversations
and so on. The political people,
who know their job, who think they know what they can
get through Congress and so on, tend to always look for partway. They tend to look
for, if you say we need to do this big
thing, well, that's hard. Let's do part of it. Their instinct is
always to do, well, part of what the economists
think ought to be done. It's very difficult to
deal with a situation where actually half a loaf may
be not much better than none. And that is kind of the
situation when you're faced with this kind of crisis. Because if you do a halfhearted
policy, although, economically, it may help, if the
economy still looks lousy after you've done the
halfhearted policy, the conclusion of the
political process is not, well, we need to do more of it. The conclusion is, well,
that policy failed, so we can't do anymore. And so that's been very much
the case in the stimulus. I can give you chapter and
verse on why the economy would be in much worse shape
if the stimulus hadn't been carried out. But the fact that unemployment
is still close to 10% means that, in
Washington, the view is, well, we've just proved
that stimulus doesn't work. And that was
somewhat foreseeable, but it was impossible
to get that across to the political people,
that doing what you think of as a more careful,
cautious policy is actually extremely risky,
because you really have one shot at this and no more. Last but not least,
the economists themselves are confused. A lot of people
probably read the piece I wrote for the Times Magazine. It had been really amazing
within the economics profession to see how much has been lost,
not by everybody, of course. But I've used the
phrase that we're living in a Dark Age
of macroeconomics. And what I mean by
that is that there's a difference between the
Dark Age and barbarism. Barbarism was, they
never knew better. Dark Age is, the people forgot
what the Greeks and the Romans knew. And to some extent, that's
where we are in economics now. It's been really astonishing
to watch economists reinventing 1930 vintage
fallacies as if they were fresh insights, because
they don't know about this. There are real
disputes you can argue. There are respectable
arguments that we should not have done a fiscal
stimulus, or that we should have done something very
different from what Obama did. But many of the arguments
against stimulus are simple failure to understand
very basic insights that were hard-won, but
hard-won 70 years ago and, unfortunately, have
been lost in the interim. So we came into this
deeply unprepared. What happens now? I don't know. I'm actually really worried
about where we are now. If you want to look at the
situation, the first year of crisis, we're at just
like what Keynes described in "The Great Slump of 1930." So we managed to replicate
the crisis amazingly. When Keynes wrote his, again,
masterwork, "The General Theory of Employment,
Interest, and Money," it was not during the
acute phase of crisis. It was not when the
economy was slumping. It was actually
written at a time when there had been a
significant but incomplete recovery. And what he was
worried about then was not so much, why does the
economy fall off the edge? In fact, one of his
great strategic decisions was, I'm not going to explain
why depressions happen. I'm going to try to
explain why they continue, why the economy can
remain stuck in a period of high unemployment
for many years on end. That's the world
we're in right now. We're in a world
where, at the moment, it's hard to see any drivers
for a really vigorous recovery. If you ask yourself
what's going to happen, something might come along, but
consumers are heavily indebted. Firms are in much better shape. Corporations are in
much better shape. But they have lots
of excess capacity. Why would they invest? Where is the demand
going to come from? Well, it could come
from governments. But politically, we're
actually kind of stalled. There is no sentiment. Instead, there's a great
deal of worry about deficits and a lot of pressure to cut
spending, not increase it. So we are somewhat caught
in a situation that is more than a little
bit reminiscent not of the onset of the Great
Depression, but the mid-1930s, where you were really
stuck in a holding pattern with mass unemployment
just becoming a fact of life. I'd like to say that
everybody is really rethinking their positions
in this environment. There's not much sign of that. What actually seems
to be happening, as far as I can make
out, is that, by avoiding utter disaster, we've
actually also managed to avoid being
forced to confront our own intellectual failings. I would not believe
this a year ago, but when I look at the state of
discussion, both in Washington and within the economics
profession, what is amazing to me is, much of
it is as if it were still 2007. And we've gone back to it. People are espousing
the same positions. People are saying the same
things, the same rhetoric about private sector,
dynamism, and the evils of big government. The same denunciations
of Keynesian economics are right back in vogue. Nothing much has changed. And there doesn't seem to be
an obvious forcing event that will change either the economy
or the intellectual climate. Something will
eventually come along. In the long run, we
will work this out, and we'll find a
way to recovery. But you know how
this is going to end. John Maynard Keynes is my
great idol in economics. And what he said about the
long run is, in the long run, we are all dead. And I left a little thing
on my notes here saying, come up with something
optimistic to say at the end. But I haven't
managed to find it. So with that, I'm going to
throw it up for Q&A. Thank you. [APPLAUSE] WU: So thank you very
much, Professor Krugman, for a wonderful talk. Another round of
applause for him. [APPLAUSE] PATTY: We have a small
gift for Professor Krugman. It is our t-shirt
that we sell for UEA. And we would like
you to have it-- KRUGMAN: Thank you. PATTY: --to remember us by. KRUGMAN: Thank you. WU: And Professor Krugman
has agreed to a few questions from the floor. So please raise your
hands and speak clearly. OK, Yeah. AUDIENCE: Hi. What are the strengths
and weaknesses of the fractional
reserve system? And do you see value in any
of the alternatives to it? KRUGMAN: OK. The question was, what do I
think of the fractional reserve system, and are there
any alternatives, which means we have banks that
accept deposits and lend out most of the money,
but only part of it in the form of liquid reserves. And there have been many
people, over the centuries, who have argued that
that's a bad thing, and that, basically, banks
should be safes, depositories for cash. You cannot do away
with that system. Remember everything I just said. We don't get to define
legally what is a bank. We get to define
legally what's going to have deposit insurance. We get to define legally
who obeys what regulations. But if you say that banks and
depository institutions are not going to be allowed
to do anything really with your money,
then what will happen is that more and
more resources will flow to other
institutions that give you ready access to your money,
but actually put it to work. So actually, it's something
like fractional reserve. Banking is going to emerge
whether you like it or not. So you can't really ban that. What you can do is, you can try
to make sure that at least most of the people who are
doing bank type activities are caught within a-- are both
circumscribed in what they do and have guarantees behind them. So the trick is not to say
that we're going to make-- we're going to go to
100% reserve banking, because if you do
that, what we'll do is you create a
perfectly safe banking sector, which is totally
irrelevant to the economy. And meanwhile, the
real banking sector will be subject to all
the crises as before. What you can do instead
is to try and make sure that the actual financial
system you have has got limits on leverage, capital
requirements, guarantees, a resolution procedure,
prudential requirements. Basically, what
we need to do is, we need to recreate
a 21st century version of the '30s, of the New
Deal banking reforms, which, we should remember,
produced half a century without major financial crises. So it's not that we don't
know how to do this. It's just that we
don't want to do it, or at least that there's an
awful lot of money and ideology standing in the way of doing it. Yeah. AUDIENCE: What do you
think about the idea that China and the United States
could determine the economy for the 21st century? And the question is
how that [INAUDIBLE].. KRUGMAN: I guess the
question was, what do I think about China
and the United States determining the economy
of the 21st century? There are other people out
there, I guess, is the answer. Europe is essentially
coequal with the United States as a player,
for good and for real. When they do well, it's
good for the world. World trade policy, which
is my original home field, is set in Brussels and
Washington, not in Washington. Brussels is every bit as
powerful in those issues as we are. India is an increasingly
large player. Japan is not
negligible, even now. And so no, I don't
think that's the way. Now, we have a
big problem, which is that China has become a
major economic power while still being quite poor, and also
while not actually operating the same way as the others do. Let me put it that way. Every two years, the
Treasury Department is obliged to report on whether
China is middling its currency. And every two
years, the Treasury lies, because of
course they are. And no, they had
reasons why they thought it was a good idea. But it becomes a real
problem now, especially in this kind of world. We are in a depressed world,
where the normal policies have lost traction, which means
that, if one country pursues that undervalued exchange rate
and runs an artificial trade surplus, that really
is a predatory policy against the rest of the world. So that's the issues
that are coming up. And then, of course,
environment-- so China is now
number one on least one thing, which is
greenhouse gas emissions. So we're going to have to find
a way to work out a system. All of our setup, all
of our institutions, are still really
designed for a world in which a handful
of rich countries dominate the world economy. And we haven't yet
figured out a way to deal with big
but poor economies. Yeah, up there. Yeah. AUDIENCE: What are your
thoughts on the future of the euro with the huge
debt prices and Spain and Portugal's economic woes? KRUGMAN: All right,
future of the euro. It's funny. When I was thinking
about the last few days, I'm very fond of speaking to
eurocrats, to people who work for the European Commission. Because they're actually
kind of fun once you learn how to do the talk. They're very smart, but
they're also straight out of "Yes Minister." And they talk in these
certain locutions which need to be translated. So the other parallel
I use is that I always think it's like the scene
in Annie Hall, where they're having a conversation
in English, but there are subtitles with
what they're really saying. And so I remember that,
back in the early '90s, I'd have conversation
with eurocrats. And they would say these
elegantly incomprehensible things about widening versus
deepening and priorities. And you finally realized that
the subtitle actually read, we should never have
let the Greeks in. So what I think about Greece
is that that's actually a case of hard cases
making bad law. Greece actually has been
fiscally responsible from time immemorial. It's been in default
half the time every other year
since independence. So Greece was sort of
bound to be an accident. And that's not really
the revealing case, although now there's some
contagion from Greece. The real story and
the reason that you need to be worried
about the euro is Spain. Spain actually behaved
quite responsibly. Just a couple of years ago,
they had a budget surplus. They had relatively
low government debt as a share of GDP. They did all the things
you're supposed to do. But they had enormous
real estate boom. It's not actually
clear what they could have done about that,
even if they had chosen to. But anyway, all the
respectable people were telling them that
there was no problem. And then when the
boom went bust, they have no adjustment
mechanism available. They really need to have their
manufacturing become much more competitive, compared
with Germany and France. But they can't devalue
their currency, because they don't have one. Alternatively, they
could get some relief if there was a lot of
out-migration of labor, as happens when individual
US states are depressed. But of course, although there's
legally free movement of labor within Europe, in practical
terms, it's not that big. So what's happening to Spain,
which now has a massive budget deficit, but only because
of the depressed economy, is exactly what euro skeptics--
people who were not sure that Europe was ready for
a single currency-- said would happen. And that is a huge problem. We're having exactly
the nightmare scenario, the asymmetric shock
to a major eurozone economy with no adjustment
mechanism available. It's not how it's going to work. No fiscal integration. When Florida has
a terrible slump, the budgetary consequences,
while terrible, are not as bad as
they might have been, because the Social
Security and Medicare checks come from Washington. Spanish social insurance checks
don't come from Brussels. So everything that you worried
about that might go wrong from this project
of a single currency is going wrong for Spain. Now, what that means about
the future of the euro, I don't know. Because it is a pretty good
example of why maybe they should have had
some second thoughts about the whole project. But dropping out of the
euro is almost infeasible. It's not clear how
anyone could do that. The last time we've seen a major
single currency area break up, as far as I know-- Peter may know
better, [MUTTERING]---- but I think it's the breakup
of the Austro-Hungarian Empire at the end of World War
I. And that was done by-- they closed the borders
for several weeks while all the
currency was exchanged and the banks' deposits
were converted. And I don't think you can
do that in the modern world. So we really have a
very ugly problem. My guess is that there might be
some at least limited defaults by some eurozone governments. It probably doesn't
bring down the euro. The zone probably
doesn't break up, because it's very
hard see how it can. But this is ugly. This is what we were afraid of. And I really feel sorry for
Spain, which really, again, played by all the
rules, and then just got sideswiped by the
combination of a huge bubble and the structural problems
of the single currency. Yeah. Yeah. AUDIENCE: So many
students here and many of whom will be
graduating will get a job and, hopefully, we save
money for retirement, since that's what my
parents helped me realize. So with the lack of
regulation that is here now and, if, let's say, the
administration and the economy doesn't pack regulations
but it kills it, there might be more of
a boom and bust cycle. So what do you recommend
for next year's student? KRUGMAN: Oh, gosh. I really hate doing
investment advice. I have to say, even with all
of that, it's a little early. When I got my first job, I got
this gold-embossed envelope on creamy paper. I thought, oh, here's
the actual contract. And it turned out to
be my retirement plan. And I was 24 years old. And really, it's too soon to
be thinking about retirement. Think about it later. Not too much later,
but not at that age. AUDIENCE: So these firms that
still got a lot of money, but they don't invest
it, shouldn't we split up these firms? Also, in the long
run, the government can be hijacked again
by "too big to fail." KRUGMAN: Oh, OK. AUDIENCE: How likely is it
that that's going to happen? KRUGMAN: OK, the
question is, should we be breaking up "too big
to fail" financial firms? Is it going to happen? I don't have any
problem with breaking up big financial institutions. I think it's not all clear
that there is any big benefit from having them. I don't believe that
they're at the essence of the financial crisis. And there are several
layers on that. One is that, even analytically,
our basic understanding of how it is when you have a
financial crisis, how you can have bank
runs, does not hinge on there being big players. You can have bank
runs even if there are many, many small banks,
which is more or less what happened in the 1930s. So there's nothing to
prevent that from happening. Breaking up "too big
to fail" does not insulate you from the chance
of a financial crisis. Conversely, having banks
that are too big to fail is no guarantee that
you will be in trouble. So we can make that
argument various ways. But the easiest one, maybe,
is to just say, look, the stellar example right
now is Canada, which is really kind of amazing. We should be looking to the
great moral and intellectual leadership from Canada. I discovered this Monday. I guess because there is
more and more Canadian stuff, for some reason, appearing,
the Times has introduced a new style rule, which
is that we are not, in fact, allowed to
make fun of the way Canadians end their
sentences, eh. But anyways, Canada
basically has five banks. Those five banks
dominate the scene, which means that, from the point
of view of the Canadian system, all of their banks
are too big to fail. And that was not at the
core of the problem. If I were going to make a
strong argument for breaking up big banks, it would be
that the big banks have too much political
influence, that they're too big to constrain
politically, that they end up being able to write legislation
on their own behalf, which is pretty much what
happened, more or less. Sandy Weill decreed the
end of Glass-Steagall. And the legislative process
was just a formality. So that's an issue,
although even small banks, through their
trade associations, can do a lot of damage. But if I had to make a choice
between getting Paul Volcker's limitations on big banks
or Elizabeth Warren's choice of a proposal for a
Consumer Financial Protection Agency, I would take
Warren's agency in a second. I think it's much more important
to act on protecting consumers from predatory or
confusing lending. It's more important to
have capital requirements. I actually think that the
bill that the House passed, the Barney Frank bill basically,
which addresses these things, but doesn't really
address too big to fail, is a really good
piece of legislation. And I wish there was some
chance it would actually get through the Senate. So it's not an irrelevant
issue, but it's not the core of the problem. AUDIENCE: What about the
companies like GM or-- KRUGMAN: Oh, big companies. GM or C-- again, the size,
that has not really turned out to be a problem here. I mean, antitrust, yes,
and you want market power. One of the good things that's
happening behind the scenes is that antitrust
enforcement seems to actually be coming back now. But that's not at the core
of the macro problems. OK, go. Yeah. AUDIENCE: So if one
of your main question be how could this happen again,
isn't it just as possible that maybe because
the economy is cyclic, maybe it was a
mischaracterization to say that we foolproofed
the economy such that it never happens again? KRUGMAN: So the question
is, wasn't it just a mistake to think
that we could set up a system so that these
things wouldn't happen again to the economy? The way I look at, actually,
is that we went 50 years without a big crisis. And we really only started
on the route to this crisis when we politically
and intellectually started to forget
about the old lessons. As long as banks were
pretty heavily regulated, as long as there was a
sort of proper suspicion of too much
creativity in finance, we were relatively
safe from these things. Now, it may be that there is
a kind of a larger logic that says that these things
will happen eventually. So people are
rediscovering Hyman Minsky, a heterodox economist. The Minsky argument
is that there is a cycle in these things,
that after crises, people become very cautious,
both in the private sector and public policy. And then that produces an
extended period of stability. And then people forget about
the risks in something. And then they revert to
all the bad old behaviors. That's basically all there
is in Minsky, actually. You can read all 400
pages, but that's what you'll get in the end. And there's probably
some of that. But I guess I always
come down to the thought that we did have an
extended period of stability without these things happening. This is not a deep
mystic secret about how you stop it from happening. We have individual
countries that have managed to largely avoid this. We even had some countries
have had terrible macro events, but still have relatively
stable banking systems, speaking of Spain. Now, given just
how bad things are, their banks might finally
just crumble under the strain. But at least so far, they've
done remarkably well. Sovereign must have
branches here too, right? Actually, if you call up
their telephone banking, you get the recorded
message which says, Sovereign, now
part of Santander, one of the world's
strongest banks. So they're saying, trust us. We're not American. We're actually Spanish. And so you can do this. It's not that hard. But it does require that
you have the political will. The people who put together
the original banking regulations were smart,
but not brilliant geniuses. They were just
willing to say, we're going to sacrifice a little bit
on possibly optimum efficiency in order to limit the risks. And we just need to
recapture that sentiment. AUDIENCE: What if [INAUDIBLE]
management [INAUDIBLE]?? KRUGMAN: All right. The question is whether
financial engineering can contribute to
growth and development? By the way, at Princeton, we
do not have a business school. So where is our
finance department? And the answer
is, it actually is in the engineering department. We have something called
ORFE, Operations Research and Financial Engineering. And that's where our
finance people are. So I guess I'm
obliged to believe in financial engineering. So there are levels on levels
of financial engineering. Bonds were a piece of financial
engineering when first created. Having some range of financial
instruments is a good thing. Let me put it a
little differently. When we say we need to
safeguard financial innovation, the question is, what
are we talking about? And it's almost a
parlor game now. Try to name a financial
innovation over the past 30 years that has been
unambiguously a good thing. And you're not
allowed to use ATMs. And it's virtually impossible
to come up with that. You see many, many
speeches about, we mustn't cripple
financial innovation, but almost no concrete
examples-- or none, as far as I know-- of what it is that's
supposed to be a good thing. Five years ago,
people would have told you all of these
great subprime mortgages, the collateralized debt
obligations, credit default swaps, all of which have
blown up in our faces. Well I've written this
a number of times. Most of the evidence
points to the idea that keeping banking boring
is really what we want to do. I'll probably take two more. One way up there. AUDIENCE: It's been said
of science that science progresses funeral by funeral. Did this effect contribute to
the Dark Ages in economics? And could it possibly
contribute to a new Renaissance in economics? KRUGMAN: OK, yeah. People didn't hear that. If science progresses
funeral by funeral, what does this say about the
future of economics, roughly speaking? Let's put this way. I don't think that the funerals
are helping us right now. I don't want to go
too far with this. Let me say, as a preface,
that the great bulk of what economists do is
not on these issues. And the great bulk of it
is careful, empirical work on many things, or careful
analysis of problems that are not in the headlines. On macroeconomics,
what happened was pretty clearly that, in the
wake of the big changes that took place in the
field in the 1970s, a lot of schools
basically stopped teaching old fashioned
macro, even when there was still a lot of
evidence that it was useful, even though there
were a lot of things that people needed to know,
MIT being one of the places where you could still get it. But what has been really
startling within profession discussion was how
many people who are in their 30's
or 40's in economics simply never encountered
the idea of fiscal stimulus and the logic of why it might
work or why it might not. They just haven't
encountered it. So in this case, the
progression actually meant that people
who knew things that we needed to remember
disappeared from the profession and were not replaced. Hopefully, if we do end
up learning something from this crisis and the
ones that will surely follow, then there will be
future generations who bring that knowledge back
and bring other things that we don't yet know. But I wish it were the case
that we had a clear progression in this field. And that's the shocking thing. In many ways, it seems as if the
state of understanding of macro was better when I
was in grad school than it is in much of
the profession now. Boy, that's a
depressing thought. Let me take one more question,
then we'll call it to an end. AUDIENCE: Do you think
that global warming will make a financial
impact on [INAUDIBLE]?? If there is no
Japan [INAUDIBLE]?? KRUGMAN: I'm sorry. Do I think that
what will cause-- AUDIENCE: The global warming. KRUGMAN: Global warming, oh. Will global warming
cause financial crisis? Well, you know, climate
change is a slow process. That's not what has
me worried about it, though God knows it could. But I think the reason to
worry about climate change is not that it will
cause a financial crisis. The reason to worry
about climate change is that is that low lying
countries will find themselves underwater, that the
southwestern United States will turn into a permanent
dust bowl, and all of these other things, which
are not speculative, crazy, something Hollywood dreams up. Those are the central cases
in the major climate models. So that's the stuff
to worry about. There is a certain
sense in which, why does any of this matter if
we don't actually tackle that? But I guess you have
to deal with problems at different timescales
all at the same time. Thank you, everybody. [APPLAUSE]
