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US risks “lost decade” due to half-steps

The United States risks a Japan-style lost decade of growth if it does not take aggressive action to stimulate its economy and clean up its banking system, Nobel Prize-winning economist Paul Krugman said.

“We're doing half-measures that help the economy limp along without fully recovering, and we're having measures that help the banks survive without really thriving,” Krugman said.

“We're doing what the Japanese did in the nineties,” he told a small group of reporters during a visit to Beijing.

He said it was not clear that China would suffer sub-par growth as a consequence of the fallout of the present crisis.

“I'm mostly worried that the US and the euro zone will have Japanese-type lost decades,” he said.

Krugman said he expected little or no employment growth this year or next in the United States, where the jobless rate in April hit a 25-year high of 8.9%.

“A second stimulus is becoming clearly urgent. They need a very, very strong stimulus,” said Krugman, a Princeton University professor and a New York Times columnist.

He said stress tests carried out on 19 leading US banks had bought time for the administration of Barack Obama, but they had not answered the key question of whether the banks have enough capital to fulfill their key role in the economy.

“It's clear the administration won't take radical action to strengthen the banks any time soon,” he said. To have done so would have meant temporarily nationalizing Citigroup and, perhaps, Bank of America, he said.

Krugman gave credit to China for vigorously implementing its own economic stimulus plan but said he had detected no commitment by Beijing to switch to a domestic demand-driven growth model that would reduce its excess savings.

“It's very hard to see how the world has a full recovery if China continues to run current account surpluses of 10% of GDP,” he said.

If China's big external surpluses persist alongside high US unemployment and low European growth, political friction will ensue. “Something will have to give, and it won't be pretty.”

Krugman said China should not be in a rush to make the yuan, or renminbi (RMB), fully convertible or to liberalize its capital account; countries at a similar stage of development that have scrapped capital controls have run into trouble, he noted.

“I'm not sure we're talking about a full-floating RMB,” Krugman said. “But an appreciation of the RMB, though it's not what China wants to hear right now, is going to be necessary.” (Reuters)