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DAVID BRANCACCIO, anchor: Now to the bigger picture. The University of Michigan's closely watched survey out today finds consumer sentiment dropping sharply in September, but that's not the interesting part. The interesting part is that most of the drop was recorded during the first half of September, a vivid reminder that the mood of consumers was souring before four planes were hijacked and the World Trade Center and a piece of the Pentagon came down. Columnist Paul Krugman wrote the cover story for the forthcoming issue of The New York Times Magazine.

Dr. PAUL KRUGMAN (The New York Times Magazine): What was worrying me just before the attacks was that there was too much resemblance for comfort between the US economy in the year 2001 and the Japanese economy in 1991. That is, we're sort of a post-bubbly economy where it wasn't clear that the conventional tools were working to turn things around. And I guess I'd say that after September 11th the situation is the same, only more so.

BRANCACCIO: But it's not like in economic terms the terrorist attacks are irrelevant. They certainly are doing something to our psyche, we just don't know what yet. And the Japanese example that you explore in your article does very much acknowledge the psychological roles in figuring out which way an economy goes.

Dr. KRUGMAN: Well, it's always been psychological. What John Manerkeens called animal spirits is always there. Under normal circumstances, basically Alan Greenspan can deal with whatever mood swings we may have. The difference now is that possibly that medicine isn't working. Greenspan has cut the Fed Fuds rate from 6.5 at the beginning of this year to 3 now, and the economy is still sliding. There are still 3 points to go. But the example of Japan, again, tells us that sometimes zero isn't low enough. They've taken the usual medicine, they've reduced interest rates to zero, they've spent a lot of government money, they've been running large budget deficits year after year. And while all of that has meant that Japan doesn't look like the US in the 1930s, it has never produced a real recovery, and that's--that's the great concern right now.

BRANCACCIO: If what was wrong with the US economy, and increasingly the global economy, was wrong even before the terrorist attacks, are you prepared to argue, Dr. Krugman, that in some sort of perverse way this hideous act of murder in New York may actually help the economy because the government ends up spending more than it ever would more quickly?

Dr. KRUGMAN: Yeah. It's--it's a terrible thing to say, but one thing that was a problem before the attack was that we were somewhat hamstrung politically. The natural answer, the thing to do to give the economy a bit of an extra boost was an increase in government spending, but that was just not on. We were against big government. Well, all of a sudden big government, if it means enhancing airport security, is not a dirty word, and so we actually have the possibility now that the kinds of policies we probably should have been following even a month ago are now actually going to be implemented.

BRANCACCIO: Paul Krugman teaches economics at Princeton. His article The Fear Economy will appear in The New York Times Magazine on Sunday.

Originally broadcast, 9.28.01