Paul Krugman is a professor of Economics and International Affairs at Princeton University, and the author or editor of 20 books and more than 200 papers in professional journals and edited volumes. His field of expertise is in international trade and finance, with his current academic research focused on economic and currency crises. Mr. Krugman also writes for a broader public audience, including his Op-Ed columns for the New York Times, Foreign Affairs, and Scientific American. Professor Krugman received the 2008 Nobel Prize in Economics.

We interviewed professor Krugman on July 25, 2009.

Will we be ultimately better or worse off as a result of the government’s massive stimulus spending?

It’s helpful to think about this question from a national point of view. The money funding our deficit spending will come from eventual increased economic output. It’s not coming at the expense of private investment. By making the economy stronger, it’s actually promoting private investment. So the stimulus doesn’t make us poorer, but richer as a nation in the long run.

No question the government is taking on an extra liability, which has to be covered through higher revenues. Higher taxes are a real cost to the economy. But I believe our country’s systemic fiscal problem is primarily due to rising health care costs. Our current deficit spending is only marginal in effect compared to this issue.

Ultimately, the question comes down to whether there is a real alternative to large government stimulus. Without deficit spending, would our long-run prospects be better or worse? I can’t come up with any analysis that suggests we would be better off without the deficit spending, both in the short- and long-run.

Are you concerned about the potential inflationary effects?

Is it possible? Yes. Likely? No, because I don’t think inflation is that hard to contain.

I don’t believe under the present circumstances a big increase in the monetary base necessarily implies future inflation. Remember, the Fed has not been printing vast quantities of money. We’ve had the Fed lending large amounts of money to the banks, which has led to a surge in bank reserves. The Fed is acting as a financial intermediary of last resort, doing what the banks don’t want or can’t do. So when banks start to lend again, all the Fed needs to do is to stop providing monetary support and start reeling in what they already allotted to banks. The Fed just needs to stop increasing the size of its lending facilities, and it has already been doing this to some degree.

However, if banks start to shift these reserves out of the deposits of the Fed and into the economy, then the Fed would need to soak up the money either through borrowing or by selling off some of the bank assets it has acquired. Either way, it’s just a matter of unwinding positions the Fed already holds.

How do you determine what stimulus spending is growth producing?

I believe in old fashioned-Keynesian thinking. Any spending in the short-run will produce short-run growth and jobs. Of course ideally you’d rather get the most out of every dollar spent. But in terms of what spending will stimulate GDP in the third and fourth quarters--there isn’t good spending or bad spending. Anything that will lead to an increase in effective demand will restart the economy.

It’s important to remember that the stimulus package has barely kicked in, a point that is lost in the 24/7 reporting on the economy. According to a recent Goldman Sachs report, only $2 billion, or less than two percent of funds allocated to infrastructure, has actually been spent. So there’s a lot more stimulus to come. And this is just a small part of the President’s overall recovery plan. Most of the package involves tax cuts and aid to state and local governments.

What type of stimulus approach do you think is most effective?

Aid to state and local governments probably has more significant impact on growth over the long run than most people can imagine because it helps avert spending cuts that will be very bad for the long term. If you’re cutting things like education and transportation infrastructure projects, that will crimp potential GDP growth far into the future. And I think expanding health care access would be a good thing as a way of making people’s lives a little less miserable and getting money into the economy. Research and education are also important long-term public investments.