It will be a W-shaped recovery: Paul Krugman

Nobel laureate Paul Krugman, who teaches Economics at Princeton University, has publicly lauded US Federal Reserve chairman Ben Bernanke’s

Paul Krugman, Nobel Laureate & Noted economist More Pictures

efforts to pull the world’s largest economy out of the ongoing recession. In a free-wheeling chat with ET NOW’s senior editor in Kuala Lumpur, Mr Krugman predicts that the US economy may step out of the worst recession in more than five decades by September, but economic problems and weakness may persist. Excerpts:

Unemployment in the US fell for the first time in more than a year. But you’re telling us not to get our hopes up...
The new claims for unemployment insurance are not as bad as they were, but still indicate a worsening labour market. So, we’re basically at best stabilising, probably not even quite stabilised. This is just okay, it doesn’t look like the world is going to end right now, but it’s not a recovery.

Will the recovery be W-shaped or a V-shaped one?
It certainly is not going to be V-shaped. There’s no driver for rapid recovery. The W (the double dip) — I guess there might be a W and it will be fuzzy, so you won’t be able to see it. But it certainly is looking like a weak recovery with a possible setback. What drives those V-shaped recoveries is the housing sector. We had this enormous housing problem which imploded. Although housing is probably stabilising now, there’s still a huge overhang of excess building and there are bad memories of what happened. We’re not going to have a traditional housing-led recovery. So, we don’t have the set-up for a traditional, strong bounce back.

US households have taken up their savings rate from almost nothing to about 7%. Is that a problem for Asia, which has traditionally depended on the US consumer for buying up its exports?
Yes, we built a system — as I was describing a few years ago — where Americans have made a living by selling houses to each other, which they pay for with the money they borrowed from China. That’s over. American savings rate is going to head higher from where it is. Historically, it was 9-10%. And remember, American households took a $13-trillion hit on their wealth between the housing collapse and prices of nearly all assets fell. They have discovered that the rising value of their house is not going to provide for their retirement. Thus, they have got to start saving again.

Some people are saying that over-abundance of global liquidity has already started pushing emerging markets into bubble territory. What is your view?
I think I wouldn’t say excess of global liquidity. What I would say is that there was a global rush to safety. And some of that money is being freed up, but it’s sort of disillusioned about the things that it was chasing in the past, and is chasing new things. So, there are indications. There may be some equity bubbles out there. There may be some even real estate bubbles in Asia resurfacing, which is frightening. So, people who were terribly burnt on the US real estate market are saying: Well, but this is Chinese real estate and it can’t have the same problems, but of course, it can.

What do you think of the Chinese stimulus package?
We are not sure how much of it is real. There has been a surge in public investment, but some of that appears to be credit, which is being used just for speculation. Some of the increase in demand for raw materials seems to have been more speculative build-up, but in inventories, there is really an increase in production.

The Baltic Dry Index has dropped so it looks like that the inventory-building phase maybe coming to an end. And, of course, there are indications of bad spending and corruption. I don’t think it’s not the beginning of a sustained period of recovery.

So, is China really stoking a bubble here?
I think it is blowing some bubbles. If I was going to buy one unfortunate phrase from Alan Greenspan, I think, it’s right that it’s froth. There’s not one big bubble but there are probably many more bubbles out there.

Does the US need another stimulus package?
Oh yes. If you believe the original estimates, the stimulus package will have added, let’ssay three million jobs, to what we would otherwise have had. The fact is that we have lost 6-7 million. And it is getting worse. This package is not big enough to close the gap by a long shot and it’s limited by time. So yes, we need another package and it has to be largely spending-oriented.

Now that the worst is probably behind us, should we still worry about things like liquidity trap?
We’re in a liquidity trap because interest rates are close to zero. I think we’re going to be in a liquidity trap for at least a year, probably till the end of next year. But there are expectations in the US of inflation coming
back in future. I think it’s crazy. In Japan, the monetary base increased by 80% in 10 years after 1997 and prices continued to fall. When you are in a liquidity trap, it just doesn’t matter.

You say in your book that financial globalisation has turned out to be even more dangerous than we had imagined. Would you like to expand on that?
Think about Iceland. Did anybody truly understand that possibility? We thought before the crisis, the risks of financial globalisation were primarily to emerging markets. But the problem was simply the high leverage and exposure to foreign assets. We have seen that Germany had no housing problems. Nonetheless, German banks can be caught in deep trouble because of the fallout from the US or the Spanish housing problems.

Markets as self-adjusting, self-correcting god-like mechanisms. Do you think that dogma is out of the window now?
There’s a great seductiveness to efficient markets here. So, efficient markets have been very hard to kill. And, I think, it may survive even this. The Asian crisis, the dotcom bubble, all of those should have severely shaken faith in self-regulating markets and yet that faith persisted pretty well. So, I’m not sure that even this will kill it.

What will be your advice to India as our budget balance is fairly scary, but the FM has said: I’ll worry about it later and play for the growth now?
I think that’s right. You do have to have a plan in place to restore a healthy budget but not this year. Not with the world economy still so fragile, not with so much excess capacity still out there.

What kind of financial regulations would you want to emerge out of this crisis?
We need to have something like traditional bank regulation extended to any financial product if it is capable of generating a crisis. We need to have some central regulatory authority being given the freedom to designate certain institutions systematically important and subject those to capital requirements with limits on leverage first of all and then other kinds of potential regulations as well.