Page last updated at 19:09 GMT, Wednesday, 3 June 2009 20:09 UK

Krugman fears prolonged slowdown

By Steve Schifferes
Economics reporter, BBC News

Krugman: 'Five or 10 years of sub-standard performance ahead'

The economic slowdown could last five to 10 years and cost trillions of dollars, a top US economist has warned.

Paul Krugman, who won the 2008 Nobel prize for economics, told the BBC that any recovery would be "so slow it would feel like a recession".

He is urging the US government to introduce a second stimulus package of $500bn (£300bn) to boost the economy.

And he rebutted claims that such a move would be inflationary, saying it was "not impossible" to reduce the deficit.

Professor Krugman, a leading Keynesian who believes in strong government intervention to restore the economy to growth, has been critical of the Obama administration for not taking decisive action quickly enough.

Too small

He says that the $800bn stimulus package spread over two years was too small to be effective, given the huge size of the US economy, and he hinted that Treasury officials were already discussing plans to give it a further boost.

We have socialised the financial system through the back door
Paul Krugman

Speaking to the BBC's Hardtalk programme, Mr Krugman said that political considerations and an attempt to appeal to moderate Republicans had led President Obama to limit his ambitions.

He rebutted claims that the US could not afford a further stimulus package with the budget deficit approaching $1.75 trillion.

"Now is the time to act," he said. "It is worth spending a lot now to avoid being in an entrenched slump."

He said that the US budget deficit could be brought unto control in the longer term, particularly if the issue of rising healthcare costs was tackled.

He blamed the Reagan administration in the 1980s for raising US government debt from 25% to 60% of GDP.

Saving the banks

Professor Krugman said that he had been surprised by how quickly the banks had been able to recapitalise themselves, but he warned that they were "still wards of the state".

He had wanted to nationalise the failing banks, but he believed the government's policy was to do the least possible in order to prevent the collapse of the banking sector, rather than taking positive steps to boost recovery.

"We have socialised the financial system through the back door," he said. "But we have created a 'lemon' socialism so that if firms get into trouble, the taxpayer will rescue them."

He argued that the situation was fraught with moral hazard, and inherently unstable.

The only answer was much tougher regulation of the whole of the financial sector, not just the commercial banks.

He was still optimistic that the Obama administration would carry out its pledge to so do, but he was reserving judgement on how effective it would prove to be.

Government is back

Professor Krugman said that the basic cause of the crisis was that America had too little regulation and the problems were exacerbated by the lack of a social safety net, "with too little insurance against the accidents of life".

He said that he believed the US would move closer to the European model of social democracy and that "intense tax phobia is no longer so strong".

Hardtalk with Paul Krugman will be shown on the BBC World on Thursday 4th June at 0330 (except Middle East, South Asia and Asia Pacific), 0830, 1430, 2030 and 2230 GMT (except Middle East and South Asia).

It will be broadcast on the BBC News channel on Friday 5th June at 0230, 0430 & 2330 BST.

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