Martin Feldstein: The Danger Ahead

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You know, there are times when inflation rates are very high, the way they were in the early 1980s, when a recession was inevitable if we were going to bring down what were double-digit inflation rates. But that's not the situation now. So I think policy, both monetary and fiscal, should be trying to avoid a recession at the current time.

What has been driving the dollar down? Do you worry about the possibility of a sharper decline?

The dollar has to continue to fall to shrink our very large trade deficit. People say the dollar is weak. No, the dollar is overly strong. The dollar is causing us to have a nearly $700 billion trade deficit. So it has to come down in order to make U.S. products more competitive in global markets and more attractive to buyers here at home.

Do you believe that the budget deficit needs to be cut?

Right now the budget deficit is really quite small. I'm a budget deficit hawk from the old days, but we're looking at a budget deficit just a little more than 1% of GDP.

Would you be doing anything different from Fed Chairman Ben Bernanke as he confronts the credit crisis?

I would have been clearer a couple of weeks ago that interest rates have to come down. And I would be signaling a willingness to continue to lower rates in 2008, unless the economy starts to strengthen. But remember, he is the chairman; he is not the entire central bank. And he has to bring along his colleagues, some of whom disagree with that view.

How is Treasury Secretary Hank Paulson doing?

I'm not a fan of the proposals to freeze interest rates on adjustable-rate mortgages, which Secretary Paulson now supports. There's a fundamental problem, which is the lenders now are no longer banks holding plain-vanilla mortgages. Those mortgages have been sliced up in many ways, syndicated, and the holders are all around the world. Are they going to be willing to continue to buy U.S. corporate bonds, U.S. mortgages, and mortgage-backed securities if the government can come along and change the interest rate because it thinks that would be good for American borrowers? I don't think so. So I would worry about what it does to America's creditworthiness in global markets.

How would you ease the pain of the subprime mess?

I don't think there's much we can do for the subprime borrowers. I think we can focus on preventing subprime problems from dragging down the rest of the economy.

Have we've seen the bottom in housing?

No. It looks like that's a story that's continuing to unfold.

Will we see a recession?

At this point, there's at least an even chance that unless policy is changed, we will see a recession begin in 2008.

Maria Bartiromo is the anchor of CNBC's Closing Bell.