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Krugman: ‘Baseball bat’ austerity is over

Growth in both the U.S. and Europe looks set to return after long years of fiscal restraint but long-term fears remain, says Nobel prize-winning economist Paul Krugman.

"We've been hitting ourselves over the head with a baseball bat," Krugman said of the U.S. economy at an event in Sweden on Friday.

"We've now stopped hitting ourselves over the head with a baseball bat. So we start to feel better."

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Krugman – a noted Keynesian – said that he has become somewhat optimistic about the near future and predicted a "pretty decent" year of growth ahead for the U.S. He highlighted several incidences where "significant spending restraint" had rescinded – including the "sequester" a series of automatic spending cuts.

He also noted the payroll tax that funds Social Security which was raised two percentage points in January. These moderations, as well as changes in health care costs, are now complete, he said, but highlighted that it hasn't been without cost.

Jerome Favre | Bloomberg | Getty Images

"We've reduced the deficit too fast. It's been a major source of slowdown in growth. We think that the fiscal austerity in the U.S. has subtracted between 1.5 and 2 percentage points off growth in 2013," he said at the event in Stockholm, which was facilitated by financial services firm Skagen.

"If you stop doing stupid things to yourself, your situation improves."

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With flickering signs of a housing recovery in the U.S., falling consumer debt and "stupid self-destructive policies diminishing", Krugman believes that the U.S. can now move on. In Europe, he believes Mario Draghi, the president of the European Central Bank (ECB), has provided an adequate backstop to help government's with their borrowing needs. This has calmed markets and allowed the euro bloc to heal too.

However, he said, the tough austerity packages imposed by struggling euro zone countries so they could get a handle on their debts haven't helped this turnaround. In countries including Ireland, Spain and Italy, governments drastically cut their spending, thereby putting the brakes on their economies. As these countries' economies contracted, their debt to gross domestic product ratios actually got worse despite measures to cut back on spending.

"All of the troubled countries have in fact seen their debt rise as a percentage of GDP," he said. "The whole situation in Europe has been contained, I would argue primarily because of the ECB."

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The euro zone bloc has managed to post positive growth figures in the last two quarters after a lengthy recession but fears remain of dwindling consumer prices. If prices of goods continue to show little pick up, the concern is that this will curb corporate investment and continue to hit growth in wages – both essential to get economies moving again.

These deflationary concerns, according to Krugman, are apparent in both the U.S. and Europe, leading him to believe that the two major economies are falling into a "secular stagnation", similar to that seen in Japan in the 1990s. Only inflation can mean that wages grow and make it easier for governments to tackle their debts and restructure their economies, he added.

"All of our economies are operating far below on what we thought we could produce," he said. "We've seen this movie…the western world is very much following the track of Japan in the 1990s," he said.

By's Matt Clinch. Follow him on Twitter @mattclinch81


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