Krugman dismisses debt crisis risk in U.S., U.K.

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Krugman dismisses debt crisis risk in U.S., U.K.

The United States and United Kingdom are immune from the kind of debt turmoil that engulfed five euro-area countries because they’re not part of a monetary union and borrow in their own currency, according to Nobel laureate Paul Krugman.

“Fear of a Greek-style fiscal and financial crisis has loomed over much of our policy discourse over the past four years and played a significant role in shaping actual policy, constituting the principal argument for austerity in countries that don’t face any current difficulties in borrowing,” Krugman wrote in a paper ahead of his presentation at an International Monetary Fund conference in Washington yesterday. The two-day conference ends today with a panel featuring Federal Reserve Chairman Ben S. Bernanke.

“However, despite repeated warnings that crises of confidence are imminent in floating-rate debtors - mainly the United States, the U.K., and Japan - these crises keep not happening,” he said in the paper.

Part of the reason is that, unlike individual euro-area nations, the three countries have their own central banks to act as lenders of last resort, Krugman said. Accordingly, every time the European Central Bank signaled a willingness to play that role in the past three years, borrowing costs of distressed economies narrowed, he wrote.

The fiscal health of the United States was at the heart of political wrangling that led to a 16-day partial government shutdown last month. A temporary agreement pushed back a deadline for a budget agreement to Dec. 13 and suspended the nation’s borrowing limit through Feb. 7, setting the stage for more debates on acceptable deficit and debt levels.

Even if confidence in U.S. or U.K. bonds dropped, the outcome would be positive, said Krugman, a Princeton University professor who won the 2008 Nobel prize in economics for his analysis of trade flows and location of economic activity.

“Claims about the vulnerability of floating-rate debtors to crisis haven’t been given any specificity because they do not, in fact, make sense,” he said in the paper. “Simple macroeconomic models suggest that a loss of confidence in a country like the United States, taking place at a time when interest rates are at the zero lower bound, should, if anything, have an expansionary effect.”

That’s because under floating rates, the adjustment would occur through a depreciation of the dollar that would lead to an increase in net exports, according to the paper titled “Currency Regimes, Capital Flows and Crises.”

Even if that generated some increase in interest rates to tame concerns of inflation, “this story - in which interest rates are driven up by economic expansion, fears of inflation or both - is not at all the kind of story told by those who portray America as just a step from becoming Greece,” Krugman said in the paper.

He also addressed a comparison with the Asian crisis of the 1990s, where large depreciations didn’t prevent an economic slump. The difference is that those economies had large private debt denominated in foreign currencies, he said. Bloomberg
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