Krugman: Two more years for full recovery

THE global economy is at a turning point but it will take at least another two years before a full recovery can be seen, economist Paul Krugman said.

“We are now at the end of the beginning,” he said.

Resulting from aggressive government stimulus, the global economy seems to have hit some sort of stabilisation although any dramatic “phoenix-like” recovery can be ruled out at the moment, according to Krugman.

“That is not going to happen this time. We cannot have an export-led recovery as the world’s economies are having serious difficulties,” he said, adding that the current collapse in world trade had debunked the earlier belief that Asia could decouple itself from the West.

Krugman, Nobel Laureate and professor of economics at Princeton University, was speaking on the Global Financial Crisis – The Way Forward at the two-day World Capital Markets Symposium organised by the Securities Commission.

Arising from the severe global financial crisis, five lessons can be learnt – financial markets are prone to bubbles; the financial system is not safe; monetary policy cannot be used to resolve all problems; budget deficits are sometimes necessary; and Keynesian policies relating to the means to stimulate output and growth do work as a source of support, according to Krugman.

Cautioning that employment indicators were just as important as those of gross domestic product (GDP) and industrial production growth, he warned against the tendency to downplay the severity of the crisis.

The world economy now looked like Japan which suffered from deflation for a long time, with a shortage of role models for possible solutions for the crisis, he said.

Krugman recommended more stimulus packages be put in place with higher inflation targets, as sitting on cashpiles was a bad idea, and improvements in business investments especially those related to climate change.

He also stressed the need for increased regulation and restructuring of the financial system to include the understanding of the many forms of banking and imposition of capital requirements as well as limitations on risk and compensation.

Krugman agreed that the United States could have been better off if it had had a bad-bank model which would be hard to implement now.

“We have propped it (the banking system) up but not made it clean,” he said, adding that he was currently concerned not so much about the return to equities but the return of exuberance.

“In terms of mindset and compensation, we seem to have forgotten the lessons very fast,” he said, referring to the surging bonuses prevailing again at US banks and that key decisions were still being made by “28-year-old guys” at the banks and major financial centres.

He stressed that the business of banking should become boring again with the need for more regulations, although there appeared to be a lack of political will in this aspect.

At a press conference later, Krugman said his forecast for full global economic growth in two years was based on an analogy of the recession in 2001 which (was felt mostly in Western countries) and ended in November that year.

However, actual growth resulting in additional jobs was only seen in the third quarter of 2003, he noted.

“That genuine recovery was led by a housing boom. This round, it may take longer,” he said, adding that Asia, which had been hard-hit by the plunge in manufactured exports, might see an inventory rebound over the next few months.

On the proposal to develop Asia’s financial markets, he said: “I do not think Asian financial markets would do much to affect the flow of funds but an Asian monetary fund in the form of regional rescue operations makes a lot of sense.”

Krugman does not think that public spending, at a maximum of about 4%-5% of GDP, would be large enough to drive the world economy to its next crisis, noting that the ballooning deficit in the United States was caused by structural imbalances such as healthcare costs.

In an interview with Bloomberg yesterday, Krugman said Federal Reserve chairman Ben S. Bernanke deserved another term based on his success in battling the financial crisis.

“He’s earned the right to a second term,” he said. “He turned the Fed into the financial intermediary of last resort. When the banking system failed to deliver capital where it was needed, he put the Fed into the markets.”

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