Paul Krugman is one of the world's most influential and provocative economists. Although Krugman made his professional mark in academia, where his work on trade and economic geography earned him a Nobel prize in 2008, it is his commentary that has brought wider public recognition. Last week, Bloomberg Opinion writer Noah Smith interviewed Krugman online about the state of the U.S economy in the midst of the coronavirus crisis. This is a lightly edited transcript of their conversation.
Noah Smith: This pandemic, and the resulting economic slowdown, don't look much like the Great Recession -- or any recession since high-quality economic data has become available. How should we think about this unprecedented event? Can we model it as a demand shock, like the last downturn? Are there any simple models here to guide us?
Paul Krugman: Is this a demand shock or a supply shock? Yes. And no. The aggregate-demand-aggregate-supply framework doesn't work well for this crisis, because it assumes that the economy can reasonably be represented as producing a single good -- a fine approach most of the time, but not now.
What's happening now is that we've shut down both supply and demand for part of the economy because we think high-contact activities spread the coronavirus. This means we can't just use standard macro models off the shelf.
But it's not all that hard to produce two-sector models that use many of the same strategic simplifications we've used in the past. I've seen really nice work on the question of whether the lockdown in some sectors spills over into recession in other sectors (Veronica Guerrieri et al.), and whether and how it produces financial market spillovers (Ricardo Caballero and Alp Simsek). I'm finding these approaches really helpful as a lens for viewing the data and the policy response.
That is, I don't feel analytically at sea here. Even though this crisis is really different from anything we've seen before, my sense is that we've got a pretty good handle on the economics. In particular, we know enough to understand why conventional responses like stimulus or tax cuts are inappropriate, and why we should be focusing on safety-net issues.
NS: So typical stimulus isn't the goal here, and instead we're merely alleviating human suffering while we wait for the shock to end. But that raises an important question: What are the constraints on government action here? In a normal, demand-based recession, there's little risk of inflation from monetary or fiscal policy because the demand shortage is acting to push prices down. But in this situation, it's not clear which way the shock is going to push prices -- the model of Guerrieri et al., for example, is ambiguous on this point. So should we worry that enormous deficits and Federal Reserve asset purchases might stoke a runaway inflation spiral?
PK: In principle it could indeed go either way. People with intact incomes could be switching to unconstrained goods and services rather than postponing spending, so that aid to the unemployed could be inflationary. But that's not what we seem to be seeing. It looks as if the private sector surplus has risen by enough to accommodate public deficits, with room to spare -- that is, it's deflationary.
One big reason, I suspect, is that Guerrieri et al. -- whose model was almost exactly the way I would have done it, so this isn't a criticism -- don't include a role for investment. The fall in demand isn't just households postponing consumption until they can go to restaurants again; it's also a crash in construction of houses, commercial real estate and so on. Who wants to build an office park in a plague?
NS: That's a good point. But this does raise another question. During the Great Recession, you were -- rightfully, in my view -- a harsh critic of people who used bad macroeconomic models to try to explain that crisis as the result of natural shifts in technology or workers deciding not to work. This time around, how do we know which economists have good models? Leaving out investment can make a model give wrong results, but it's a fixable problem. What sort of theories and ideas should we absolutely shun?