Paul Krugman: The Economic Failure Of The Euro Using a shared currency has made it difficult for Europe to recover from its economic crisis, Nobel Prize-winning economist Paul Krugman says. He explains why the euro experiment may fail — and what that would mean for the global trading system.
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Paul Krugman: The Economic Failure Of The Euro

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Paul Krugman: The Economic Failure Of The Euro

Paul Krugman: The Economic Failure Of The Euro

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This is FRESH AIR. I'm Terry Gross.

Can Europe be saved? That's the question my guest, Paul Krugman, asked in his article about the euro's role in Europe's financial crisis. He writes: Not long ago, Europeans could say that the current economic crisis was actually demonstrating the advantages of their economic and social model. But now, Europe's proudest achievement, the single currency adopted by most European nations, is in danger.

Krugman's article about what he calls the euro mess was published two Sundays ago in the New York Times magazine. He's a Nobel Prize-winning economist, a columnist for the New York Times and a professor of economics and international relations at Princeton University.

Paul Krugman, welcome back to FRESH AIR. Does the fate of the euro affect the American economy?

Mr. PAUL KRUGMAN (Nobel Laureate; Economics Professor, Princeton University): Well, some. I mean, that's not the main reason to care about it. The main reason to care about it is that Europe matters, and it's, you know, we want them to succeed.

But, sure, I mean, we export to Europe. We're all in this world economy together. But really, that's not the core of why we should be concerned.

GROSS: What is?

Mr. KRUGMAN: Well, Europe is the great extension of the democratic experiment, right? We have the United States, and then for much of the 20th century, across the water was a continent in terrible trouble, a continent of war, dictatorship.

Now, we've had, for this past 60 years, a grand experiment in democracy, a decent society, peace. We want that to work. You know, that's what we stand for, ultimately.

GROSS: So which European countries are in the biggest financial trouble now?

Mr. KRUGMAN: Well, it's pretty much all around the edges of Europe. So, Greece, obviously, although Greece is actually kind of unrepresentative, Ireland, Portugal. On the eastern side, Estonia, Latvia, but - and the big one is Spain, which is much, much bigger than all of the others. And all of these countries are in serious trouble now.

GROSS: So is there a fear of a possible default, that they won't be able to make good on their bonds and that people will be left holding the bag?

Mr. KRUGMAN: Yeah, I mean, in fact, if you look at what's happening in the markets, where the price of bonds, basically, as a way of measuring how much, how likely the investors think it is that they'll default, the people seem to take at least a partial Greek default as almost a foregone conclusion. They take an Irish default as highly likely, and they're pretty concerned about Spain. So sure, these are real possibilities.

GROSS: And what would that mean if one or more of the countries defaulted?

Mr. KRUGMAN: Well, you know, it's not the end of the world, or it needn't be the end of the world. But it would just mean that one of these countries would say, as Argentina did in 2002, okay, we can't pay this stuff, we can't pay this stuff, and we're going to demand a reduction in our debt. And that's - it doesn't mean that grass grows in the streets, but it does mean that it's very much going to shake confidence. It's a bad sign. It's a step back towards the old world of fragmented countries and unreliable governments.

GROSS: So one of the things I liked about your article is that it had a nice, concise history of the European Union and the euro. You call the euro like a great experiment. So let's just step back a little bit and look at that experiment, but let's go back to what you describe as the roots of the European Union, which was this steel and coal agreement. Would you talk about that agreement?

Mr. KRUGMAN: Yeah, so if you go back to just a few years after World War II, 1950, you had - a lot of Europe was still in very great economic difficulty. It was a very troubled time. A lot of people expected that the bad old days of war and division would come back.

And there was a very specific problem, which was that at that point, France had a lot of steel capacity but didn't have enough coal, and Germany, West Germany, had a lot of coal, but there was no very good way to strike a deal with the French.

And the French foreign minister proposed a, basically a pooling of the two countries' industry, so that German coal would be available for French steel plants and, ultimately, that you'd basically have a lot of trade in steel and coal products between the two countries, which was an important thing economically.

But right from the beginning, the French said this is more than that. This is the step on the road to a federated Europe. This is a way to end war because war will become actually impossible if we actually have a coal and steel industry that sprawls across the border between our countries. And we're going to - by positive achievements like this, we're going to build a new Europe.

It's actually - you wouldn't think that a speech declaring a proposal for something involving coal and steel could be an uplifting, inspiring document, but it is.

GROSS: And, of course, France and Germany had a long history of war between the two countries, two wars in the 20th century.

Mr. KRUGMAN: That's right, three big wars in total. And sure, I think if you have said in 1944, just six years before, with the war still raging, that actually we're going to have a grand gesture of conciliation and unification between these two countries, you would have been mocked as unrealistically optimistic. And yet, there it was.

GROSS: So did that coal and steel community, this agreement between France and Germany, expand into or evolve into the European Union?

Mr. KRUGMAN: Well, yes, it set a precedent. It was very successful, and it met with favorable reaction. And so just about eight years later, they formed what was originally the Common Market and then became the European Community and now the European Union.

So it set the stage for this coming together of Europe into something that wasn't quite a nation but was something more than just a bunch of separate countries.

GROSS: So what is it, exactly?

Mr. KRUGMAN: Well, Europe is, it's a funny - it's something that is a kind of halfway house. You know, at one level, it's a customs union. So there's free movement of goods. You know, we have something similar, a little less integrated, in North America with NAFTA, but it's - the European integration is closer.

And then there's a bunch of pan-European institutions, the European Commission, a whole bunch of ways in which Europe has taken some of the functions of government and made them something that sprawls across national boundaries.

So it is a step. If you like, it's a little bit like America before the Constitution, during the Articles of Confederation period, when we were sort of a country, but in a lot of ways, we were still a bunch of sovereign states. The Europeans have gotten to that stage.

GROSS: So which countries came first in the union, and which came later?

Mr. KRUGMAN: Oh, well, the original is, the original six is Germany, France, Italy and the Benelux countries, so it's, you know, Belgium, Netherlands, Luxembourg. So it's starting in that core.

But it has, you know, in a series of stages, it's expanded. Britain was hesitant at first but did join. They brought in - so, you know, at this point, just about all of, well, I was going to say just about all of Western Europe; all of Western Europe and now a lot of Eastern Europe is really part of this broader system.

GROSS: So when did the idea of the single currency, the euro, come about?

Mr. KRUGMAN: Wow, I think probably people have been talking about it since time immemorial. It was - I think it was in people's minds. I'm not enough of an expert on the history of the concept to be sure exactly, but I'm sure it was there even in the '50s.

But it got serious in the 1980s. In the '80s, the Europeans took a big step, the Single European Act, which was going beyond just free trade to harmonization of regulations, the euro-sausage was the joke made about it, but basically saying that food standards, environmental standards, safety standards would be the same across Europe, that there would be legal freedom of movement for individuals within Europe. And then the question was sort of, well, what next? And the single currency was what came up as the seemingly obvious next step, right from the beginning.

GROSS: Well, let's look at the pros and cons. What are some of the advantages for the European countries of having a single currency?

Mr. KRUGMAN: Well, actually, the advantages tend to be more obvious than the disadvantages. The advantage is you can hop on a plane in Barcelona and land at Berlin and never have to change money. That a contract that's signed between a company in Italy and a company in the Netherlands, there's no question, you know, whose currency is this going to be denominated in and what's it going to be worth given the exchange rate on the day the thing comes due.

So it makes business a lot easier. It's smoothing things. To use the example I used in the article, if you imagine that Brooklyn had a different currency from Manhattan, there'd be a fair bit of inconvenience involved in changing your Brooklyn dollars for your Manhattan dollars every day. The euro eliminated that kind of inconvenience within Europe.

GROSS: So what are some of the disadvantages of the single currency?

Mr. KRUGMAN: The disadvantage is: What happens if you really need to make an adjustment between two countries? What if - well, it's not a what if now - you had an enormous housing boom in Spain. That housing boom led to a rise in Spanish wages and prices compared with wages and prices in Germany. Then the housing boom went bust, and really, Spain needs to get back to a more competitive level of wages and prices.

That's actually very, very hard if what's required is actual cuts in wages, whereas if Spain still had its old currency, the peseta, you could just devalue the peseta, and at one stroke, you would have gotten those costs and prices back in line.

GROSS: So what is Spain doing now?

Mr. KRUGMAN: Well, Spain is in the early stages of what the Europeans -the Europeans are great ones for jargon. Their euro-speak is a language all its own. So what they call internal devaluation, which in a way tells you, though, we're trying to do what would have been done if only Spain still had its own currency.

But they're doing it instead by just squeezing down wages and prices, that they're just - we've got a lot of unemployment, they've got 20 percent unemployment in Spain now, and that's going to gradually lead to workers accepting pay cuts. And if they do that big enough and long enough, then eventually Spanish industry will be sufficiently competitive again.

GROSS: So what you're saying, I think, is that a downside of the euro is that each country doesn't have the equivalent of a Fed.

Mr. KRUGMAN: That's right. It doesn't have the equivalent of the Fed. It doesn't have an exchange rate it can use. Sure. I mean, if you look at the countries that stayed out of the euro, whether it's Sweden or Britain, they still have their own Fed equivalents, the Bank of England, the Riksbank, and they were able to pursue independent monetary policies that have given them a lot more flexibility in this crisis than the countries that did go onto the euro.

GROSS: Now, is there a euro-Fed, like a central bank for the European Union? Yeah?

Mr. KRUGMAN: Yeah. Yeah, there's the European Central Bank, which is structured a lot like the Fed. We have regional Fed banks, like the New York Fed. They have the old national central banks, like the Banque de France, are their equivalent. And they set monetary policy.

In normal times, the ECB, the European Central Bank, functions a lot like the Federal Reserve, but of course, it's setting policy for the whole of Europe, and it's - as people say, there's a one-size-fits-all problem. The monetary policy that may seem appropriate for Germany may not seem appropriate for Spain.


GROSS: So, you know, in talking about the euro, I'm really interested in hearing why England decided to never sign up with the euro and to maintain its own currency.

Mr. KRUGMAN: Some of that was a bit of national pride. In other words, there were some reasons that weren't very rational. You would have had to replace pound notes bearing a portrait of the queen with euro notes with pictures of generic bridges and doors on them.

But a lot of it was that there was a - put it this way, in Britain, policymakers and economists were very conscious of the issues I just talked about, about the loss of flexibility that would come with not having your own currency. And they...

GROSS: The loss of flexibility in creating your own monetary policy for your country.

Mr. KRUGMAN: That's right. You wouldn't be able to do what Britain did in this crisis, which was to aggressively cut interest rates in order to try and insulate yourself from some of what was going on.

And in Britain, those - the skeptics had the ear of important people. In particular, they had the ear of Gordon Brown, who was at that point chancellor of the exchequer, in effect treasury secretary, who more or less told Tony Blair: No, we're not going to do this.

Tony Blair, I think, was caught up in the European dream and did want to join the euro, but Gordon Brown said, you know, this would be a really bad idea and was able to make that stick.

GROSS: So has that isolated England financially?

Mr. KRUGMAN: Well, they - no. I mean, the interesting thing, one of the arguments was, well, if we don't join this, terrible things will happen. We'll be cut off from trade with Europe. We'll lose the role of London as a financial center. And none of that happened. It turns out that Britain is very closely integrated with the European economy. London has thrived as a financial center, which has actually turned out to be a problem because they suffered disproportionately when world financial markets went to hell.

But no, it turns out that the predictions that countries that did not join the euro would somehow become pariahs on the European scene has not turned out to be true.

GROSS: So now that some of the countries in the European Union are doing really poorly financially, like Greece, Ireland, Portugal, Spain, what pressures is that putting on the countries that are doing better financially?

Mr. KRUGMAN: There's a couple of things. There's certainly at least some pressure to have a more inflationary, expansionary, whatever, policy by the European Central Bank, although the ECB has not done that. They've actually been fighting, and they're talking very much about the need to control inflation, I think inappropriately. But there's certainly some of that.

But the main thing is nobody really wants to see a default. Nobody really wants to see Greece, or much worse, Spain, failing to pay its debts because that would be very disruptive to the European economy.

A lot of the bonds, you know, a lot of the money ends up being owed to other Europeans, and particularly to other European banks. So there's a lot of German bank money on the line. So there is some sense that, hey, we are not independent, we're not insulated from each other. A default by a major European country would be a tragedy for all of the Europeans.

GROSS: I think there's discussion now about whether the more prosperous countries should basically be bailing out the countries more at risk and to the tune of how much money. Yeah.

Mr. KRUGMAN: Yeah... Well, at that, you know, the United States, a lot of what I've said about Europe, you might say, well, doesn't that apply to the United States, as well? And there are a number of reasons why the same issues may exist, but they're not of equal size.

And in the United States, we have a kind of automatic system of bailing out because if you have a severe recession in some state, the amount of taxes they pay to Washington drops sharply, but the amount of Social Security and Medicare benefits that flow in continue. So we have that process.

The Europeans have, they don't have anything like that mechanism. There's a lot of aversion on the part of the German taxpayer to the idea that they might have to bail out Greece. But some kind of help - well, we already have large amounts of lending taking place from, official lending to try and get these countries through. But the trouble is it all looks well short of what's actually needed to deal with the problems.

GROSS: What you're doing here is kind of making an analogy between a state within the United States and a country within the European Union in terms of what they get financially from being in that union and what limitations they have. So why don't you make that comparison a little more. What's the difference between a country in the euro zone and a state in the United States?

Mr. KRUGMAN: Well, yeah, that's been, that's not just, you know, some literary device. That's actually the way a lot of the economic analysis of the euro has worked. We have an example of a continent-wide currency union that functions. It's called the United States.

How much does Europe look like that, how much does it not look like that? And the parallels, since both the United States and Europe managed to have financial crises following housing bubbles, there's a lot that we have in common. It's - it makes a lot of sense to think of Spain as sort of being Florida and to think of Ireland as sort of being Nevada, being small populations, huge housing booms, huge housing busts.

But the difference, there are really two differences that matter. One is that the United States does have a common language and a common culture, so that people move, in the United States, out of depressed regions into regions with better job prospects much more than the Europeans do, although they do move to some extent but not as much as we do.

So we, in the United States, we have this single language. There was an old joke - I'm sorry, I'm wandering here, but there was an old joke about creating the common European language. And it says, well, you know, as a practical matter, it has to be English, but it begins suggesting modifications, and by the end of the memo, it's turned into German, which in a way illustrates the problem.


GROSS: Now, the Europeans have had a very strong safety net for people who are unemployed, health care benefits. There are countries like France that have very good benefits for new mothers. So there's a strong safety net there. But there's more and more people now who need that safety net because of unemployment. So how has that affected the economies in European countries? And I'm wondering also how that's affecting your thinking about strong safety nets and their pros and cons.

Prof. KRUGMAN: I think it cuts both ways. On the one side, those strong safety nets have meant that the amount of sheer misery in Europe is considerably less than here. You've actually had a roughly same depth of recession in terms of GDP, in terms of industrial production in Europe, as in the United States. But in the United States, that has really meant incredible individual hardship. In Europe - even in the troubled economies, and very much so in the stronger economies like France or Germany - there just hasn't been - things have not been so terrible.

Actually, unemployment hasn't risen as much in Europe as it has here because there are more - there's more regulation of hiring and firing, which has helped to sustain jobs. And those who do lose their jobs don't lose their health benefits. They have a lot more support. So in a lot of ways, Europe is weathering this crisis better, as a human process, then we are.

On the other hand, European budgets - because they have such a strong social safety net, European budgets are hit very hard when there is an economic slump. So some place like Spain, they moved from a budget surplus to a huge budget deficit in the face of the slump, and it's not because of anything - or not much because of anything the Spanish government did. It's just because, well, they had a lot of taxes, and the revenue has plunged, and they have a lot of benefits that have to be paid because of their system. They are, in some ways, more fiscally vulnerable to a slump than we are.

GROSS: Are many European countries now considering cutting back on those benefits because they can't afford them anymore?

Prof. KRUGMAN: You often read newspaper stories about the - in this country about that, and they tend to be way overblown. The Europeans are talking about some changes. The French are talking about trying to raise their very low retirement age, and so on. But it's always worth bearing in mind that what passes for a hard-right, extremely conservative, anti-welfare-state politician in Europe is, in general, to the left of any significant figure in the Democratic Party in the United States. So they're in a different universe of discourse about these things.

GROSS: So what are some of the options that face the European Union now in dealing with the financial crisis?

Prof. KRUGMAN: There are things they can't do. They can't adopt a single language. They can't turn into America at a stroke. They can try to enhance some of these ways in which strong countries can aid the weak countries. They can turn Europe into more of a transfer union, as people say, something where there is some automatic aid to countries that are in trouble. They can probably provide significantly relief right now if the strong countries are willing to back or guarantee at least some debt issued by the weak countries. This is the euro bond idea.

But I think, realistically, it's hard to see this working out without at least a couple of countries, in fact, getting a debt restructuring, getting, saying okay, look. We can't actually pay all of this. Let's do a workout where we only pay some fraction of it.

GROSS: Which would mean that people who bought bonds only get back a percentage of what they were promised?

Prof. KRUGMAN: Yeah. Something. I mean, the extreme example - I don't think any European country's going to do this. But the extreme example in recent history is Argentina, which said we're not going to be able to pay this, and eventually reached a settlement with bondholders at about 35 cents on the dollar. So you can imagine something like that happening for Greece, for Ireland, little less likely for - well, substantially less likely for Spain.

GROSS: Are you getting a sense that citizens of the stronger countries are starting to resent the citizens of the weaker countries because of the stress being put on the stronger countries who are expected to help the weaker countries in this financial crisis?

Prof. KRUGMAN: Yes. And vice versa. One of the really destructive things about this - if you want the European idea to succeed - is that if you look at what's happening in Ireland right now, on the one hand, the Germans are feeling that they are put upon, they're being forced to bail out those irresponsible Irish. And the other hand, the Irish are feeling that the Germans have turned into these cruel, heartless money collectors who are turning Ireland into a subservient colony. It's an ugly scene. It's not what you want to see happening.

GROSS: Is it a threat to the union?

Prof. KRUGMAN: I think that's a long ways off. I think it takes a lot -to put it this way, there's a possibility that one or more countries would end up being forced off the euro, forced off the currency -although even that's a pretty awesome prospect to - it's not something that would happen easily. The European Union itself, I think, is not going to - is not that much in danger. But what's in danger is the - is the - is faith and progress. The European Union, for the past 60 years, has been a process of ever-greater integration, ever-greater progress towards the idea of Europe as a single, democratic entity, as opposed to a bunch of quarreling countries. And now all of that is in danger.

GROSS: So you said there's the possibly of one or more countries being forced off the euro. How would they get forced off the euro? What's the likelihood, and what's a possible scenario?

Prof. KRUGMAN: So I think it's reasonably likely, maybe 50 percent odds for Greece, and lower for the others - although if one goes, there might be a chain reaction here. The way it would work would be that ordinary people, probably, Greek citizens start to think, you know, they're not want to be able to make this work. They're going to have to reintroduce the drachma and devalue it against the euro. And in anticipation of that, they say, boy. I better get my money out of Greek banks and into some place where there will continue to be euros.

So they start pulling their money out of Greek banks and putting them into German or French banks, and that's a bank run. And that itself forces action. The Greek government is forced to do something dramatic. It's forced to temporarily close the banks. And then once it's done that, it may say, you know, this will just start up again if we open them, so let's get this over with. And they introduce a new currency.

That's more or less what actually happened in Argentina in 2001. They had a supposedly permanent, irrevocable peg. The Argentine peso was one peso, one U.S. dollar forever. But they had an enormous bank run, and that led to the Argentine peso actually no longer being worth one U.S. dollar, in fact, being worth only about 35 cents for a while, there. And so that's - you know, so that's the story. You can easily see - well, you can see how it could happen. It would be an enormous thing. It's by no means a certainty, but that's how the euro could at least partially break up.

GROSS: Can a country just go back to its old currency? I mean, it's not like the currency has been waiting in hibernation to be started up again.

Prof. KRUGMAN: No, that's right. And that's why you can't just do it casually. You can't just have a - let's have a debate in parliament about whether to go back to the drachma, because if you did that, you would, in the moment that the debate began, you'd have a massive bank run.

So I don't think it's possible for anyone to say, coolly and collectedly, you know, it'd be a good idea. We were wrong to join this euro thing, and we should go back to the drachma or the peseta, because everybody knows that even to raise the subject is to create a banking crisis. But the thing is that the banking crisis might happen, anyway. And if it does, then that's when you go off the euro.


GROSS: We have been talking about your New York Times magazine article about the euro, which was printed two Sundays ago. And one of your main points about the euro is that it's hard for the countries in the economic union who are in financial trouble to get out of it because they don't have an equivalent of the Federal Reserve Bank in their own countries. They don't have a country equivalent to manage the kind of monetary policy that the Fed does - print more money, print less money, raise, lower the interest rates.

In the meantime, it's been really interesting in the United States. There's this movement to, like, end the Fed that's - leading the charge is Ron Paul, who's now actually head of the House Financial Services Subcommittee on Domestic Monetary Policy. And this is the subcommittee that basically oversees the Fed. So I'm just really curious what your reaction to this is, knowing how important you think the function of the Fed is.

Prof. KRUGMAN: It's important. I mean, I think for the time being, the Fed is not going to find itself forced into liquidating itself and we're not going to go to the gold standard. But it actually is a significant inhibition on the Fed. I think they're going to be less aggressive than they would have been.

And I have to say, this is something I did not see coming. It did not occur to me before about a year and a half ago that, faced with a massive collapse in the world economy, faced with exactly the same situation that Milton Friedman said the trouble was with the - that the Fed did not print enough money during the Great Depression, that we would find ourselves with a powerful political movement saying what we need is for the Fed to stop printing money, that what we really need is to do away with all of this effort to use monetary policy to rescue the economy. That's been kind of a shock to me, although I think I now understand where it's coming from.

GROSS: And Milton Friedman, I should say, is a - was a revered conservative economist.

Prof. KRUGMAN: That's right. And so what's happened now in the debate over economic policy is that we actually have a situation where if Milton Friedman were alive today and making the kinds of pronouncements that he made about U.S. policy during the Great Depression, or the pronouncements he made about Japan in the '90s, he would be viewed as a leftist. It would be the Friedman-Krugman axis here of - the axis of monetary evil. So that's an amazing development on the American political scene.

GROSS: So there are some conservatives now who want to see a return to the gold standard and to end the Fed. In Virginia a subcommittee was created to study a monetary alternative in case the Fed breaks down and to consider the gold standard as an option. What does the gold standard mean? What's the difference between being on and off the gold standard?

Prof. KRUGMAN: Okay. Right now we're on a - I guess we could say we're on the Bernanke standard. The amount of money in circulation is determined by the amount that the Fed thinks ought to be in circulation, and the Fed, in turn, you know, makes its decisions about that based on considerations of unemployment and inflation or the lack thereof.

On the gold standard, at least in the strongest form, what you do is you say we're going to say that a dollar is worth a certain number of ounces of gold and that we're going to adjust this quantity of money based on that target. End of story. The state of the economy, the overall cost of living have no bearing. It's just we're only interested in one cost, which is the cost of an ounce of gold.

You know, we had a system like that once upon a time. Many economists believe that the attempts to sustain that system played a big role in making the Great Depression as bad as it was. But now we have a political movement that thinks that going back to that would be a good idea.

GROSS: There's something so appealing about the gold standard, because you know exactly what a dollar is worth, a certain amount of gold. Whereas now, like what's a dollar worth? Like, who knows. It's a piece of paper, depending on monetary policy, you can get this or that for that single dollar bill...

Prof. KRUGMAN: Yeah.

GROSS: ...or the $10 bill, and it's fluctuating. It doesn't have that clear-cut value that a gold standard provides.

Prof. KRUGMAN: Yeah. Although it's worth pointing out that since by and large we don't eat gold and we don't live in gold houses, that a dollar that had a fixed firm value in terms of gold would have a wildly fluctuating value in terms of the things we actually buy. Whereas, the dollar we actually have has a pretty predictable value.

Yeah, we sometimes have two percent inflation. We sometimes have one percent. We sometimes have three percent. But by and large there are not huge fluctuations in what a dollar actually buys. So that's the funny thing. You know, gold seems like a, you know, solid, hard standard, but it's a standard that has very little relationship to, you know, what we actually do and how we actually live. It's illusory in a way. The idea that there's something especially sound about it is an illusion.

GROSS: Let's look at another economic issue facing the United States now. It's before Congress now whether to raise or not raise the debt ceiling. Would you explain what the debt ceiling is and why this is an important issue?

Prof. KRUGMAN: We have a funny, actually a rather bizarre system here, where Congress decides on the budget twice. They decide on taxes and spending but they also - there's also a limit on the amount that the U.S. government is allowed to have in debt, which is constantly being breached. That is there's this sort of further limit, this further red line that you're not supposed to cross except that we continually cross it, rightly or wrongly. And so every time we get close to that red line either Congress has to raise it or the federal government has to stop borrowing, which means bringing a lot of government activities to a screeching halt.

So the thing is that I think in a way the way this is functioned is it's pretty easy for politicians to say we must not raise the debt limit because that doesn't commit them to exactly how it is we're going to avoid passing it. So they don't have to commit to actually raising taxes or actually cutting any particular spending. They just say we must not raise the debt limit and so at least do a lot of grandstanding and possible confrontations in the U.S. government.

GROSS: But say the debt ceiling wasn't raised. What would that mean?

Prof. KRUGMAN: That's a much debated question. Right now the federal government is not taking in enough revenue to pay for its spending, mainly because the economy is still depressed and so revenue is depressed as well. But still, the fact of the matter is that the U.S. government cannot continue its operations, cannot continue meeting its promises unless it can raise more money by borrowing.

On the day that the debt ceiling is reached, there are probably various ways that they can keep the thing running without too much disruption. You can dip into various kinds of cash accounts, you can ask vendors to accept a delay in their payments and so on. But if it goes on for a long period of time then wow, you are forced to shut a lot of government offices and maybe eventually, you know, stop sending out Social Security checks.

GROSS: Would it also mean defaulting on paying back other countries?

Prof. KRUGMAN: Well, certainly one option would be to go into arrears on our debts, to stop paying interest or principal on some of the debts. I'm not sure that that's something that you do early on in the process. But yeah, if you look at where does your taxpayer dollar go in the U.S. government? The big things are Defense, Social Security, Medicare, Medicaid and paying interest on the debt we already have. So that would certainly be one of the things that might be on the list of things to go behind on payments.

GROSS: The U.S. has never decided not to raise the debt ceiling and therefore, defaulted on anything, right?

Prof. KRUGMAN: Well, we had a government shutdown in - I think two government shutdowns in '95, which were - but they were not, no one was seriously trying to say okay, we're going to stop right here, no more borrowing. What those were were power-plays. Those were attempts by Republicans led by Newt Gingrich to force Bill Clinton to accept sharp cuts in Medicare. So that's what's actually in the cards.

We're not actually talking about, I don't think, we're not talking about anybody going into a situation saying okay, that's it, no more borrowing, the U.S. government has to live within its means. That's, neither party wants anything like that. What we're talking about possibly is a game of chicken between Republicans and President Obama.

Given that that didn't work out for them too well six years ago, I think the general belief is that they probably won't do it. But even if they do, the point is it's not really about the U.S. reaching the end of its debt limit. It's about jockeying over trying to say who is going to bear the blame for this and therefore who is going to blink in terms of more fundamental policies?

GROSS: Paul Krugman, thank you so much for talking with us.

Prof. KRUGMAN: Thank you.

GROSS: Paul Krugman is a columnist for The New York Times and a professor of economics and international relations at Princeton University.

Coming up, Maureen Corrigan reviews a new biography of J.D. Salinger. This is FRESH AIR.

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