Paul Krugman: ‘I’m surprised that we haven’t experienced more of a slowdown’

Paul Krugman sits in a room in the Vigo auditorium in Spain, enduring the sweltering heat of the summer’s first heat wave. “What a world!” he says, referring to this manifestation of climate change, before adding, “I know Madrid is worse.” However, the Nobel Prize winner and prestigious U.S. columnist is not so pessimistic about the economic situation. During his presentation at the Vigo Global Summit 2023, organized by the Free Trade Zone Consortium of the Galician city, he claims that the economy will not be badly hit by this inflationary crisis, which, in his opinion, is already beginning to ease.

Question. When we met in the Spanish city of Valencia one year ago, you told me that, in one year, inflation would be at around 3%. And in Spain’s case, you were right.

Answer. Really? I’m happy about where we are right now.

Q. The president of the European Central Bank (ECB), Christine Lagarde, does not seem to be overly impressed with the data and has announced tougher measures to combat inflation.

A. In fact, in the eurozone as a whole, it is still there. I don’t understand why disinflation hasn’t been fast for Europe, but if the U.S. is any indication, it will come. So anyway, a year ago, we optimists were trying to make some excuses for why the data might be worse than the reality. Now it is the opposite. It is the pessimists who are trying to claim that the data is giving a misleading impression. But it’s getting harder and harder to argue against that.

Q. The mandate of the ECB is 2% in the medium term and now inflation in 2025 is predicted to be at 2.2%. How far will central bankers go for those two decimal points?

A. I think we have much more uncertainty. These forecasts have been consistently wrong. They have been too optimistic about inflation and too pessimistic about employment. Should we take the 2.2% forecast seriously? I don’t think so. There’s certainly a lot of uncertainty about the natural rate of interest. In the case of the U.S., I’m not that surprised that inflation has decreased, given the labor market data and where the real economy is at. What does surprise me is that, with the current interest rates, we haven’t experienced more of an economic slowdown.

Q. The economy has held up well, so far. But aren’t you afraid they’re going too far?

A. To return to 2%, a higher unemployment rate may be needed. Is it so important to return to 2%? The central bankers believe that not getting back to 2% would hurt their credibility. Which is probably right. They also believe that their credibility is extremely important, which is probably false.

Q. Don’t they need authority over the markets?

A. The real economy is the thing that matters, not the markets. The central bankers’ belief that credibility is an important factor for the battle against inflation is really not supported by any data. Of course, what they do has significant effects on the economy, but their belief that the credibility of the markets is key to them is much less justified than they think. Imagine if you’re a central banker, you spend all your time talking to people who hang on to every word you say. But it’s not Wall Street, the City of London or Frankfurt who actually set the prices and salaries, so I’m not sure the credibility of the central banks matters much in this regard.

Q. And if they set the interest rates on which millions of mortgages depend?

A. On this issue of variable mortgages, I think perhaps it is a sort of historical accident in Europe. The fact that most of the U.S. mortgages are a 15- or 20-year fixed rate mortgages is really helping to prevent indirect impacts.

Q. Central bankers have convened in Sintra, Portugal, and have warned about wage increases. What is happening regarding corporate profits?

A. Salaries have not directly driven up inflation because profits have risen more than salaries. And some, while not all, of the margin increases we have witnessed reflect an exploitation of market power. I do believe that greed is a factor, but not the dominant one. At the same time, you cannot curb inflation if salaries are rising so fast. In this case, I think Lagarde is right to look at salaries, because it is one of the measures to monitor to see if the economy is overheating. And rapid salary growth is an indicator that the eurozone economy remains that way.

Q. International institutions are calling on governments to withdraw incentives. What should be done on the fiscal front?

A. I’m not sure what the situation is in Europe. In the U.S., they have virtually all withdrawn. At other times, in another political universe, now would be the time for a temporary tax hike to dampen demand. But that is not going to happen.

Q. Increase them?

A. Yes, we did it in the U.S. in 1967 and 1968. President Lyndon Johnson temporarily raised income taxes to try and limit inflation, which now seems inconceivable.

Q. In the run-up to the July elections, the Spanish right wing is proposing to lower them.

A. Ah yes, that’s the great zombie idea that low taxes are a stimulus for economic growth in the long term. All the European countries have much more generous social safety nets than the United States has. By and large, that’s a good thing. It’s not discouraging people from working, because labor force participation is now high. So, realistically, how would a fiscal contraction happen? Spending is mostly being done on good things. Tax increases are politically impossible. So, for the time being, it’s all on the monetary policy.

Q. After the inflationary crisis of the 1970s, there were adjustments in the U.S. Will this be the case this time?

A. We’ve gone from roughly 9% to place to 3% inflation with no rise in unemployment at all. So, it’s not looking at all like what happened last time. So, I’m fairly optimistic that we can get through this without doing anything. The analogy with the 1970s just looks like a very bad one this time.

Q. Has inflation led to an increase in inequality?

A. No, it’s actually the opposite in the United States. Everybody assumes that inflation must hit poorer people harder, but it’s not been the case. What we’ve actually seen in the U.S. is that wage increases have been substantially larger at the bottom than at the top. So, we’ve actually seen a significant compression of inequality in the United States during the Covid-19 era. We have reversed about a quarter of the rise in salary inequality since the 1980s. So, it’s a lot. It’s really been the lowest paid workers that have been experiencing income growth faster than inflation.

Q. But aren’t those with the least resources going to the supermarket the ones who notice the price increases the most?

A. That’s true, but as long as inflation is largely reflected in the increase in food and energy prices. Both of these are a big part of the family budget. So, when you have inflation that’s driven by food and energy, then it seems to increase inequality. But energy prices are way down now. And in the U.S., food prices are now coming down.

Q. Do you follow the Spanish economy?

A. I haven’t done my homework at all.

Q. People have always said “it’s the economy, stupid,” but in Spain activity is growing, employment is too, and inflation is below 2% and, in contrast, in the last elections the voters did not reward the governing parties. Are we moving in another direction right now where the economy is not the main thing?

A. That may be so. In the U.S. we had our last midterm elections in November. And everyone was expecting a big Republican wave because the economy was in a terrible state, but that didn’t happen. I don’t know what Spanish polls are saying, but something peculiar is happening in the U.S. If you ask people, how they are doing financially, they’ll say “pretty well.” If you ask people how is the country’s economy doing? They’ll say it’s terrible. So, it’s all very puzzling. It seems as if people’s perceptions have become quite delinked from the economic reality.

Q. In your speech, you spoke about the power of some social networks and media outlets.

A. In the U.S., we run have surveys asking people if they have listened to or seen positive or negative things about several issues in the media. About employment, for instance. In the midst of a gigantic jobs boom, we were adding 200,000 or 300,000 jobs a month and people said that the news they heard was mostly negative. Some of this is manipulation. We have Fox News, we have partisan media. For example, President Biden gave a press conference yesterday to talk about the $40 billion in new investments and it received no coverage.

Q. But then you have media that are saying that climate change doesn’t exist. And then here we are in the north of Spain.

A. Yes, and I know Madrid is worse. My wife is from Texas. Postal workers have been collapsing, with some of them dying there. What a world!

Q. What challenges do you think Spain is facing?

A. I know Portugal better because I have a very longstanding personal connection. But I think Spain is actually one of the relatively good stories. Considering how severe the debt crisis was at the beginning of the last decade, the economy has clawed its way back. There are some countries that really seem to be going backwards. Germany, I think, is actually in deeper trouble than people realize. Spain, not so much.

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