SYNOPSIS:

DONALD VAN DE MARK, CNN ANCHOR: Complacency is precisely what worries my guest tonight. He says the world could again confront economic crisis if the plans for financial recovery don’t lead to action. Joining me now, MIT economics professor Paul Krugman. Welcome back to MONEYLINE, Paul.

PAUL KRUGMAN, MIT: Great to be here.

VAN DE MARK: So is—are policy makers too complacent or are U.S. investors maybe too complacent?

KRUGMAN: All of the above. I mean, there’s a couple of things. One is that the big Sashimi, Japan, is still in very deep trouble. That’s an economy that’s being kept from the abyss by massive government deficit spending that can’t be continued. So we have one clear and present danger still lurking out there. It’s a huge one. It’s the world’s second-largest economy. The other thing is we—the world came close to ending and didn’t quite end, and so now we’re all declaring a party, and that seems to me to be a bit premature. What we’ve learned is it’s a pretty dangerous place.

VAN DE MARK: How do you explain the U.S. economy’s performance in all of this, because in the fall of ‘97 and again last summer, a lot of people in New York or in the U.S. thought there was real concerns and then we’ve sailed through it?

KRUGMAN: Well, I mean, the direct linkage of stuff, I mean, sort of straight forward exports fall and we lose jobs and that creates a recession, everybody who does the numbers knows that those aren’t as strong as people think. The contagion that’s taken place has been psychological. It’s been investors losing confidence, and somehow we’ve managed to keep ourselves psychologically isolated from the rest of the world. We shouldn’t forget that last fall, for a few weeks it looked like the end of the world in this economy. You know, we had—our bond markets closed down, we had what amounted to a 1931-style bank run, except it didn’t involve the banks, and the Fed is not even sure now how they got out of that.

VAN DE MARK: What about deflation, because that was a buzz word that a lot of people were throwing around as a potential hazard? It hasn’t hit the U.S. It’s hit some other economies. Do you think that that’s really a concern, deflation?

KRUGMAN: If you’s asked me two years ago, I would have said no, can’t happen. We have the tools to prevent it. Now I look at Japan, I look at Germany, where they’re pretty close to it. I look at a lot of the problems, and you have to stay that it’s a clear and present danger in Japan. A deflationary spiral is something that could happen any month now in Japan, despite everything they’re doing. And, yes, it’s turned out that deflation, once it gets started is much harder to stop, which is another reason not to be complacent.

VAN DE MARK: Do you feel out of step because the Asian markets have done well recently? I mean, Japan seems to be recovering. There’s talks of a tax cut-inspired recovery.

KRUGMAN: I like to think of myself as being somebody who’s a little bit—steps back a little bit. I mean, I wrote a warning that the Asian miracle wasn’t all it seemed to be in 1994...

(INTERRUPTED BY BREAKING NEWS)

VAN DE MARK: Welcome back, everyone. Professor Krugman, one more quick question: Exchange controls of some kind you think are necessary?

KRUGMAN: In emergencies, and if we are complacent, there will be more emergencies.

VAN DE MARK: All right. Paul Krugman, MIT professor of economics. Thanks very much for joining us, we appreciate it.

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