SYNOPSIS: German interview. Covers issues of the Euro, Inflation, (or lack thereof,) and continuing Eurosclerosis.

Taggespiegel: In three years the euro will be launched. Will the new currency lead to booming prosperity or straight into catastrophe?

Krugman: The euro is simply a bad idea economically, even if neither of those scenarios comes true. If I compare the pros and cons, the cons have more weight. But nobody has recognized them in time. Now it's too late. Nobody wants to say that the decadence of Europe will come with the euro. But the really important question is: how will Euroland be governed?

How, then?

I worry about that. So much has changed since the European states decided for the euro in Maastricht in 1991.

What has changed?

Deflation is suddenly a problem again. By contrast, inflation is hardly one anymore. We had financial crises that nobody expected. In that situation, what is needed is a central bank that can evaluate the risks, both of inflation and of deflation. The bank may be neither too strict nor too lenient.

Then the European Central Bank should not take the German Bundesbank as model?

No – and the Bundesbank is more flexible than it is reputed to be. I fear that the European Central Bank is not the right bank for Europe.

Is Wim Duisenberg the right man?

Hopefully he will teach me a lesson, but the European Central Bank would need someone like Alan Greenspan, who understands that deflation is as big a problem as inflation. And at the moment I see prices falling all over Europe. Nevertheless it seems that growth will slow down and unemployment increase next year. What effect the recent lowering in interest rates by the European Central Bank will have, one must wait and see.

Do we then really have deflation?

I think it's better to have an inflation rate of two or three percent and interest rates of five to six percent than to have no inflation at all.

Why?

When a recession comes, you have at least the choice to lower interest rates. The US had in 1991/92 a recession during which the Fed lowered the interest rates by six percentage points – from nine to three percent. And it wasn't even a very deep recession. The fact that we today, at the high point of the economic cycle, have practically no inflation, limits the alternatives for economic policy. One can hardly conceive what would happen now in the case of a crash in the stock markets. We don't have enough maneuvering room. Cutting interest rates makes the outlook more stable. Inflation should increase to one or two percent.

Shouldn't we tame inflation?

Britain had for years an inflation of two to three percent, the US had similar high rates for a while. You are right: who reaches an inflation of twelve percent will have problems. But who aims at two to three percent will be successful. Only hyperinflation can't be controled.

Why do central bankers see it differently?

Central bankers are always more afraid of inflation than of deflation. If a central banker aims at an inflation rate between zero and two percent, he will always be very proud if he can get as close as possible to zero. And he will do all he can to reach that goal.

What does zero inflation cost – besides flexibility?

Jobs, since wages don't fall, even when prices do. That means that companies' costs remain high while their income dwindles. The consequence is growing unemployment. I am convinced that there is a correlation between inflation and unemployment, even if there is much disagreement among economists; at least at an inflation rate of one, two or three percent.

And that's the most important cause of our unemployment?

The main cause lies in the structural difficulties. But yes, another reason is: the inflation rate in Germany is too low.

Then you agree with German Finance Minister Oskar Lafontaine that lower interest rates create new jobs?

I agree with him on that point, but that doesn't mean he's right. His policies for job creation are wrong. For I believe fundamentally in the Anglo-American model, according to which new jobs are only created when the labor markets are flexible. Interventionist labor market policies, as Lafontaine wants, increase unemployment. He wants to set the clock back and calls for more strict regulation, Europa-wide. The policy now pursued by Germany is a combination of intervention in the market and a conservative monetary policy.

What about government spending in order to reactivate the economy?

The hard part is to decide who's going to get the money. In most cases only few profit from such programs. Another problem is the resulting budget deficit. I would always give priority to monetary policy.

What about high-tech programs, such as investments in the Transrapid [planned high-speed train system]?

Well, that's only a small investment program that has almost no weight. Nevertheless European technology seems very good to me, European productivity is at about the same level as the American. Technology is not the problem, but jobs.

What do you think of introducing German rules in the whole of Euroland, such as social standards and wages?

That would be hard for the others. If the European Union introduces those generous standards, countries like Portugal would lose their advantage of lower prices. Portugal would become a sad region like eastern Germany. Labor-intensive production has migrated from northern into southern Europe precisely because of the differences between Germany and Portugal.

At the top of the agenda in Euroland is tax harmonization, which is a source of controversy.

The British are skeptical, they see that as the takeover by continental Europe. The British have quite low taxes on labor, and they assume – probably rightly – it to be one reason why they are more successful in creating jobs than their European partners. The French would possibly say that England is doing wage dumping and so question one of Britain's progresses.

What's the problem?

European integration was a nebulous affair. At first it had to do with technical questions, such as standards, in order to define, for instance, what a sausage is or how the common currency should work. And now, suddenly, it has to do with reorganizing society. That's one problem. And the biggest problem of the EU is that it's undemocratic in a dramatic way.

Some say that Germany is doing quite well, others, that it's doing badly. What's your opinion?

Germany is suffering of euro-sclerosis. Unemployment is too high, even in western Germany. After each recession unemployment stays higher than last time. There are altogether too few jobs. In Germany you always say that German companies are exporting jobs abroad. But that's not what's alarming. The worst is the dramatic lack of jobs in the service sector. The reason is the labor market policy that makes new jobs too expensive. Too much regulation, too high taxes and the sum of social expenses that make labor too expensive.

Is Germany no longer competitive?

Germany is a country that exports more than it imports. That's good, people obviously like German products. But things are getting worse. That's why unemployment is increasing, and one may ask where that's going to lead to.

Do German companies move to the Czech Republic because they can produce more cheaply there?

Certainly, but that's not a zero-sum game. If more is produced in the Czech Republic, the Czechs will do better and they will buy more products, also from Germany. Trade is always a positive-sum game, where one gets more than before.

Not everyone believes that.

Of course. When labor-intensive products are no longer made in Germany, the pressure on less skilled workers increases. But it is very likely that northern Europe has created so far at least as many skilled, high-wage jobs as the less skilled ones it has lost.

What makes you so optimistic?

The example of the US. That's an economy that is much more open towards globalization than Europe's. Of course there are fundamental problems that have widened income distribution. But average wages have also increased with productivity. Unemployment remains low and inequality hasn't gotten worse.

And why do so many still believe that free trade or globalization is to blame for their problems?

Because that's so easy.