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Nobel Prize-winning economist Paul Krugman delivered the inaugural Kellogg Distinguished Lecture on Oct. 27.

Paul Krugman

Nobel laureate Paul Krugman delivers Kellogg School lecture

Economist and New York Times columnist outlines cause of current financial ‘mess’ and predicts further drop in housing values

By Matt Golosinski

10/27/2008 - In his first public appearance since winning the Nobel Prize on Oct. 13, Princeton economist and New York Times columnist Paul Krugman delivered an address to an overflow audience at the Kellogg School of Management. 

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Krugman’s Oct. 27 speech drew more than 1,000 people who listened as he discussed the intersection of U.S. economics and politics, particularly noting recent developments in what has become a global financial crisis. His address was the first in the Kellogg Distinguished Lecture Series, a new initiative sponsored by the school’s Office of the Dean. 

In his remarks, the international trade expert presented a gloomy economic forecast, noting that the U.S. currency crisis was now spreading to the rest of the world - despite a $700 billion rescue plan recently passed by Congress. That plan, Krugman said, even with some incremental improvements to its original version, "still looks weak, and it looks small" compared to the enormity of the challenge. He cited Japan's efforts at a similar bailout in the late 1990s, suggesting that a comparable effort on the part of U.S. lawmakers now would require some $2 trillion.

“A lot of the things that we thought we had under control are not under control,” Krugman said, referring to the scope and perniciousness of an economic problem that he indicated had more in common with the 1930’s Depression than with the “stagflation” of the 1970s.

One especially dangerous aspect of this crisis, he said, was the rapidity with which it has spread worldwide. As early as this spring, Krugman pointed out, many economists - himself included - still espoused the theory that developing countries were “decoupled” from economies like the U.S. and Europe, and therefore were immune from a financial implosion there. That theory, Krugman said, “turns out to be entirely wrong.”

A host of other contributing factors, Krugman said, fed into creating “one hell of a mess.” Among these was the response of Alan Greenspan, former chairman of the Federal Reserve, to the dotcom crash earlier this decade. By reducing interest rates and keeping them low over time, the Fed laid the groundwork for a subsequent market bubble in the housing sector.

The Internet bust was somewhat “more forgivable,” Krugman said, because “at least we had this amazing new technology” to show for it. He viewed the housing bubble, which he called “pretty predictable,” less favorably and said that its rupture has played a key part in the present crisis, especially as construction and consumer spending have stalled. While house values have already fallen about 25 percent, Krugman said, he predicted an additional 15 percent drop.

Another factor that has fed into the crisis, according to Krugman, was the carry trade, a practice where investors borrow in low-interest currencies and lend in high-interest currencies. “You borrow in yen to build houses in Spain,” he explained. “People thought they had the risk under control.”

Millions of readers best know the Princeton University professor through his weekly Op-Ed piece for the New York Times; he joined the paper in 1999 and has been a columnist there since 2000.

The author of more than 20 books, most recently The Conscience of a Liberal, which examines the rise and fall of the middle class, Krugman helped establish what has been called “new trade theory.” His work in this arena, beginning with a 1979 paper, has overturned long-held views about trade that date to English political economist David Ricardo. Among Krugman’s insights in this regard is a rationale for why only a few countries, similar to each other, dominate international trade.

For his research into trade patterns and the location of economic activity, Krugman was awarded the Nobel Memorial Prize in Economic Sciences on Oct. 13.

Writing about Krugman this month in the New York Times, Harvard economist Edward Glaeser stated: “His models’ combination of realism, elegance and tractability meant that they could provide the underpinnings for thousands of subsequent papers on trade, economic growth, political economy and especially economic geography.”

Some of those likely to write such papers were in the Kellogg audience, and after his remarks Krugman engaged students in a question-and-answer session that included his perspective on how the U.S. might begin to get out of the financial crisis. He said that he sees public works projects as one important element, citing infrastructure repairs on bridges, roads and railways as potentially beneficial. He also sees a role for commissioned artists: “I’m a big New Deal romantic.”

Such an agenda would be more probable under a Democratic president, Krugman suggested, adding that the financial crisis had made it more likely that voters in the upcoming U.S. presidential election would choose Barack Obama over John McCain. Regardless of the outcome, though, the new administration would have to act fast to stem additional economic damage, Krugman said. “This is no time for a lame-duck administration and a lack of authority.”

With his appearance, Krugman launched the Kellogg Distinguished Lecture Series. The initiative is another effort by the school to bring real-world insights into academic discourse. Over the coming months, the series will feature preeminent speakers from the worlds of academia, journalism and business to address key issues and critical leadership challenges facing managers today.

The inaugural event, which was open to the entire Northwestern University community, occurred in the Donald P. Jacobs Center and was broadcast to other areas of the school to accommodate student demand. Kellogg hosted a reception for Krugman in the James L. Allen Center after his lecture.