23 May 2012

Paul Krugman on euro rescue efforts: 'Right now, we need expansion'

In a SPIEGEL interview, economist Paul Krugman argues that this is not the time to worry about debt and inflation. To save the eurozone, he says that the European Central Bank should loosen monetary policy and the German government should abandon austerity.

SPIEGEL: If Greece should leave, will this finally contain the euro crisis or, rather, make things worse?

Krugman: What happens if Greece leaves? Then you have again a bank run in other peripheral countries because they've set the precedent. But, again, that could be contained with lending from the ECB. What has to happen is that the ECB has to be willing to replace all euros withdrawn as is necessary. And I think the case we're making for that lending becomes a lot easier because the Greeks were actually irresponsible. The Greeks actually did behave badly, and so the political case for unlimited exposure to Greece is very hard to make. A much easier case to make is for Spain and then Portugal and Italy, all of which did nothing wrong on the official side. So you could argue that the bad actor has been ejected, but we need to save the good actors.

SPIEGEL: But is the ECB ready to act in the way you propose?

Krugman: We will see a big flood of money out of Spanish and Italian banks, and then the ECB has the choice to accept a big increase in its exposure to those countries. The ECB lending that much money with ultimately the Bundesbank on the hook for a lot of it -- that seems impossible. But if you say the ECB won't be willing to do that, then the euro blows apart. And allowing the euro to fail -- that's impossible. But one of those two impossible things is going to happen.

SPIEGEL: You have repeatedly pointed out that Germany's pushing for austerity will lead Europe on a death trip and that prosperity through pain is a fantasy.

Krugman: That's right. I thought it was obvious from the beginning that this is never going to work. If the policy makes any sense at all, it's through mass unemployment, driving down Spanish wages. How many years is that supposed to take given that we've seen that, even with close to 25 percent unemployment, you will have a glacial pace of wage adjustment?

SPIEGEL: What do you want the ECB and the German government to do?

Krugman: First of all, give the green light to the ECB and say: Price stability is the mandate, but it's not defined. So the reality is we're going to need to see 3-plus percent inflation over the next five years. No more tightening, no more raising interest rates at the first hint of inflation, even if it's obviously a commodity blip. If anything, cut interest rates. Open-ended lending to governments and banks.

SPIEGEL: And Berlin ...

Krugman: ... should not be doing austerity in Germany. I'm tempted to add that I wish for all of that and a pony as long as we're wishing for things we don't expect to get.

Full interview

© Spiegel Online