CNN's Fareed Zakaria sat down with economists Paul Krugman and Raghuram Rajan, and both men painted a very gloomy picture (to say the least) for what kind of shape the United States economy is going to be in if all we have is gridlock for the next two years, which Krugman believes is inevitable.

Krugman also thinks that we'll be facing at least one government shutdown in the next two years. And of course as Eric Cantor already said today, if that happens the Republicans will try to make political hay out of it and put the blame on President Obama.

Anyone who didn't realize what they were voting for when they put these TeaPublicans back into office are going to be finding out the hard way very soon. And if the Democrats don't start acting like they care about the working class in this country instead of catering to corporate "centrists" and Blue Dogs, they're not going to fare much better. It would be nice to see some Democrats who aren't Republicans with a "D" behind their name trying to get some of these House seats back we lost this time around. I know this blog and Blue America will be doing their part to see that it happens.

Transcript via CNN.

ZAKARIA: Paul Krugman wrote before the election that if Republicans took control of even one House of Congress it would be, quote, "terrible," unquote. Well, of course, that's what happened on Tuesday, so how terrible will it be?

"New York Times" columnist, Nobel Prize winner, Princeton professor Paul Krugman joins me now, along with Raghuram Rajan.

Rajan was the chief economist of the IMF, is now a professor at the University of Chicago Booth School of Business, and his last book, "Fault Lines" won the "Financial Times'" Business Book of the Year Award. He and Paul Krugman have sparred in blogs and essays, but I believe this is the first time they will do so in person, if they do indeed spar. Paul Krugman, what is going to be so terrible about the Republicans coming to power?

PAUL KRUGMAN, THE NEW YORK TIMES: Mostly - well, first of all, there's almost likely, almost certain to be extreme clashes. I would put pretty heavy odds on - on at least one government shutdown during the next two years. This is going to be - you know, we're looking back fondly on the statesmanship of Newt Gingrich.

But, beyond that, it means no action. It means that we're probably going to see unemployment benefits, extended unemployment benefits, expire at exactly the moment when that would do the most harm. It means no chance of doing anything, really, to tackle the economy's problems.

So we're basically going to be uber -- Herbert Hoover-ing our economic policies at exactly the worst moment for - for the American public.

ZAKARIA: Do you think it's going to be terrible?

RAGHURAM RAJAN, UNIVERSITY OF CHICAGO: I'm going to do a two- handed thing. It could be reasonable if they come together and focus on both expenditure and - and tax reform. Both are needed to put this economy back on the sustainable fiscal situation.

I think gridlock, with 10 percent budget deficits to GDP is a very bad idea. So, if the outcome is gridlock, terrible.

KRUGMAN: But of course it's going to be gridlock. I mean, if you - if you believed that the Republicans and the Democrats can come together, you must have been asleep for the last 20 years.

RAJAN: No, no. It's a hope. I'm not saying it's a likelihood.

KRUGMAN: Yes. Yes.

RAJAN: I think it's a hope.

KRUGMAN: It's a no chance.

RAJAN: It's a hope. If you think there's no chance, I think we have serious problems. Even -

(CROSSTALK)

ZAKARIA: ... it's 10 percent budget deficit, 10 percent unemployment and two percent growth. The status quo is pretty unsustainable, and you're going to get effect of using that as status quo government.

KRUGMAN: Yes. Exactly.

ZAKARIA: You said, in one of your columns a couple of weeks ago, that you thought Obama was going to be blamed unfairly for having moved too far left, and that the more accurate criticism would be that he didn't move left enough.

I have to confess, this - this line of argument puzzles me, because liberals turned out and he got 95 percent of the vote. The big difference was a lot more conservatives turned out, a lot more Republicans turned out, and independents crucially broke and went and voted for Republicans.

KRUGMAN: I wouldn't - I don't think I said that he didn't move left enough. I said that he didn't do enough.

What he did, crucially, was settle for a really inadequate fiscal stimulus, take a relatively light touch on the banks. So he didn't do things that might have produced a better economy.

So, I mean, overwhelmingly, the midterm was public disenchantment because unemployment is still close to 10 percent. He failed to deliver on jobs.

No amount of positioning, you know, appearing, sounding more conservative, whatever, could have changed that fact. What could have changed that fact would have been a stronger economic policy. Maybe he couldn't have gotten it, but that's - the point was they played it safe, saying, well let's not push too hard on economic policy, got a weak economy, and got an electoral disaster.

ZAKARIA: But you - you had exit polls showing people thinking that the government basically had gone too far left. It was doing too many things, they were wording - voting for conversation Republican candidates. You're saying if they have regulated the banks more, these guys would have, instead of voting for Tea Party candidates, voted for them?

KRUGMAN: People respond - what - whatever people say, what we know overwhelmingly from the political science studies is that it's the state of the economy or, actually, more accurately, the trajectory of the economy, and a year or so before an election that matters.

If the economy had been - you know, if unemployment had been falling, if unemployment had been eight and a half instead of 9.6 and falling, people would have a very, very different view of what was happening.

The notion - I've been thought to be very cynical about this. The notion that people have a set of ideas about ideology, about what - what governments should do, and they'd reward or punish governments based on whether they actually follow that ideology just is completely not true. People may say that, but what they actually do, or how they vote is determined very much by the rate of economic growth in the couple of quarters before an election.

ZAKARIA: So you know that the "Wall Street Journal" editorial page is going to hear this and say, you see, people like Paul Krugman just don't want to hear that the public rejected the Obama agenda.

KRUGMAN: Well, you know, I don't think people like the "Wall Street Journal" admitted in 2008 that the public rejected the Bush agenda either.

What happened was this wasn't a - an unsuccessful economic policy. I mean, possibly - we can argue that it was successful in avoiding things that are even worse, but you have to deliver. For political purposes, you have to deliver actual improvement, not failure of things to get even worse, and they didn't do that.

And so, it was not an ideological referendum. If you actually ask, voters also thought that Republicans are terrible. They hated both parties, and -

ZAKARIA: But they voted for Republicans.

KRUGMAN: They voted because they were protesting about the state of the country, which was, you know, lousy - lousy employment picture.

ZAKARIA: Would you agree, Raghu, that this is a failed economic policy from your mind (ph)?

RAJAN: I wouldn't say failed. I would say it hasn't done enough on reviving the economy, and I would argue that some of the things that need to be done, places where it has to expend political capital, and I think that it expended far too much political capital on universal health care, which I think we need, but, unfortunately, that took time and energy off the things that need to be done.

One, we've got a banking sector, especially small and medium sized banks, they don't have enough capital. They can't support a recovery when that happens, and the lending that needs to take place.

Two, we've got mortgages, which are heavily under water, which need to be renegotiated. We need to spend political capital in creating a solution to that problem, and, right now, there's no - no will to do that.

And third, I think we've created a lot of uncertainty in health care, in the financial sector with these new regulations. We need to make clear what those regulations will be. Undoubtedly, there's a need for reform, but let's make clear, so that businesses know what they are, can then start going out and hiring.

We've essentially created an overload of uncertainty on those areas of the economy, which are big, important. And - and I think more capital on those and less on - on health care might have been more effective.

ZAKARIA: Uncertainty. Businessmen keep saying that that - it is the uncertainty, that regulatory and tax uncertainty that forced - that causes them not to spend the almost $2 trillion that is on the balance sheets.

KRUGMAN: You really need to be a little careful. Business lobbyists say that uncertainty is the big issue. I actually surveyed businesses and asked what's their problem. They say it's inadequate sales. There - there's no good reason to believe that business investment is being held back because of uncertainty about the health care law, which actually - it's actually fairly clear what that is, or any of these things. What you have is, in a depressed economy, with manufacturing operating not much more than 70 percent to capacity, with office buildings vacant, with malls vacant, why are businesses going to invest more? They already had more capacity than they need.

So this is - this is largely a canard, and just the whole argument about political capital. Lots of people say that, there was a failure to focus on the economy, but they almost never explain what it was that Obama should have been doing, right? And I - I actually view the - the whole focus argument as - as a piece of intellectual cowardice. It's a way to criticize the economic performance without actually saying what you would have done differently.

ZAKARIA: Let's just stick, though, with your main point, which is this is the classic Keynesian argument. You are in - you are in a moment where there is simply insufficient demand in the economy.

Consumers aren't spending, businesses aren't spending. The only entity in the - and the only player in the system that can produce demand is the government, so the government should be spending. What's wrong with that argument?

RAJAN: What should the government do? Can it do it efficiently? Can it do effectively?

We always have in mind large construction projects. We've done that. We've run the gambit of large construction projects which (INAUDIBLE) the bottom of the envelop - of the drawer.

What we do next? It takes time. And it's not probably going to be done in time for the recovery.

ZAKARIA: OK.

RAJAN: So the real question is, what do you spend on?

But this idea that somehow there's a button you can press and somehow the government will create spending, which will certainly revive the economy, I think is a canard, and is probably something that is not - not wise.

ZAKARIA: I've got to interrupt you guys. We are going to take a break. We're going to come right back to have this discussion cum debate. Paul Krugman, Raghuram Rajan, right back.

[...]

ZAKARIA: And we are back with Paul Krugman from "The New York Times" and Princeton University; and Raghuram Rajan from the University of Chicago, but, before that, chief economist of the IMF.

What I want to ask you, Paul, is aren't you going to get some of what you want, which is the Republicans keep talking about tax cuts. Now Keynes actually talked about both, tax cuts and government spending as a way to revive the economy, and if the Republicans give you a bunch of tax cuts, isn't that -

KRUGMAN: OK, now, the trouble with tax cuts is that a temporary tax cut is likely to be saved, not spent. And we know that. That's - that's -

ZAKARIA: We've had three.

KRUGMAN: In fact, that's - that's Milton Friedman. Milton Friedman's theory of - of consumer behavior is that temporary windfalls in income are likely to be saved, not spent.

And now - so can we do permanent tax cuts? Well, have this long- run budget problem. So if you ask, well, what are we going to do that would - that - that would increase demand a lot? Well, we can have big temporary tax cuts, but they're likely to be ineffective, or we can have somewhat smaller, permanent tax cuts, but they're going to worsen the long-run budget outlook.

Add to that the reality that the Republicans - you know, let's be realistic politically - Republicans are not going to say, let's strike a deal to revive the economy. We're going to take some tax cuts that last just a year or two. They're going to try to leverage their position into getting what they want, which is permanently lower taxes, which are then to - going to be used to starve the beast in the out years.

This is not going to work. This is just going to actually worsen.

We - we do have - you know, I'm not one of those people who says that there is no budget problem. There is a longer-run budget problem. Look at the U.S. budget outlook for the year 2025, and it's not a pretty picture.

So we cannot afford to do things that permanently worsen the U.S. budget position. And yet, if we do things on the tax side that are only temporary, they're - it's not going to work, particularly, by the way, if it's tax cuts for the rich, who are the most able to - to smooth out their spending. So, you know, in the end, if - if the Republicans are willing to agree to something that is a - like a temporary payroll tax cut, it's not - it's a pretty poor substitute for actually doing spending on infrastructure, but it may be better than nothing. If they want to do - you know, let's extend the Bush tax cuts indefinitely, that's - that's a policy to do very little in the short run and make the long run worse.

What we're likely to get is some extension of the Bush tax cuts, which, you know what was at stake always was only the high-end tax cuts. And so we - it we get a temporary extension of the high end tax cuts, that's - it would be hard to devise a less efficient stimulus policy.

This is almost guarantee - this is giving money precisely to the people least likely to spend it, and so it will worsen the federal budget outlook while delivering hardly any punch to the economy.

ZAKARIA: I'm guessing that - at least on that issue, you probably agree? That temporary extensions of the Bush tax cuts will not do much?

RAJAN: Probably not. I - I do think that it's a - it's a little problematic raising taxes substantially. But, in the medium term -

ZAKARIA: Now you're talking a Keynesian. You can't have it both ways.

RAJAN: No, no, no. I think we -

ZAKARIA: If raising taxes -

RAJAN: I need - I think we need to do things in the very short run, which deal with some of the problems that Paul is talking about. Too many people are becoming long-term unemployable, and what we need to do is try and move them back into the labor force. We need to focus on those -

ZAKARIA: How do you that fast?

RAJAN: I think you need to focus on skill building. We need - there are programs out there. Many of them don't work. We need to pick ones that work and try work with them.

But I think the real point this crisis is telling us is that America needs to shift. That America, for too long, has seen a deterioration in the underlying fundamentals of the economy, and in an attempt to - to paper over that, we've blown up the economy again and again with monetary policy, perhaps with fiscal policy.

At some point, we have to realize that the fundamentals aren't that good. Too many people are falling behind. Too many people don't have the skills and the education they need to compete in this world.

But, differently, I think the U.S. is a little bit like a car with brakes sort of on, and it - malfunctioning. You sort of get - got to get the brakes to work. But, in the meantime, what we're doing is we're trying to fill the engine with higher and higher octane fuel in an attempt to get it go - to go faster, when in fact the brakes are well and firmly, you know, malfunctioning.

Let's remove those brakes, fix the underlying structural problems, we will go faster.

ZAKARIA: Last word, Paul Krugman.

KRUGMAN: Time is not on our side. The longer this goes on, the more Americans have been unemployed so long that they're no longer employable. We don't have, I believe, a lot of structural unemployment now. But give us two or three more years of this, and we will.

The longer this goes on, the more we head towards a deflationary trap. Look at U.S. inflation rates and Japanese inflation rates from - from 20 years earlier, and we're right on top of the Japanese. We're matching the Japanese track exactly. And more deflation means that the debt burden gets worse.

So we're actually in a situation where there are heavy costs being paid right now. We are not in a recovery in any sense that matters. But, during the years of the bubble, there was a - a great overexpansion of indebtedness by parts of the population, and we cannot have a permanent recovery unless people get a chance to pay that down, and that's - that's what booms do.

Booms - you know, we know that World War II produced an economic recovery. Why didn't the U.S. economy slide back into depression after the war was over? And the answer was that during the war, during the boom, the - the private sector greatly reduced its debt burden. That's what we need to do right now.

But, of course, the point is, given the midterm elections, the next two years, at - at minimum, are awash, and none of this is going to happen.

ZAKARIA: And we're going to have to leave it at that.

Thank you, Paul Krugman, Raghuram Rajan. Right back.