Economist can't rule out recession

Nobel Prize-winning economist Paul Krugman sees about a one-third chance the United States economy will slide into a recession during the second half of the year as fiscal and monetary stimuli fade.

"It is not a low probability event, 30 to 40 per cent chance," Krugman said yesterday in Atlanta, where he was attending an economics conference.

"The chance that we will have growth slowing enough that unemployment ticks up again I would say is better than even."

Krugman, 56, said growth would slow as the Federal Reserve ended purchases of securities, the Obama Administration's US$787 billion ($1.07 trillion) stimulus programme winds down and companies stop rebuilding depleted stockpiles.

The Princeton University professor joined Harvard's Martin Feldstein and Columbia's Joseph Stiglitz, another Nobel laureate, in sounding an alarm for the world's largest economy during the annual meeting of the American Economic Association.

Feldstein called the fading stimulus "a serious cloud", and Stiglitz said growth won't be "robust" soon.

While inventory rebuilding might have raised US growth to a more than 4 per cent annual pace in the fourth quarter, this year's rate would be "more like 2 per cent", with the risk of outright declines late in the year, Krugman said. Unemployment "ends the year a little higher than it began", Krugman said.

Krugman's forecast is more pessimistic than the median estimate of 58 economists surveyed by Bloomberg News in early December, which called for a 2.6 per cent expansion this year following a 2.5 per cent contraction in 2009.

The Federal Reserve's plan to end purchases of US$1.25 trillion of mortgage-backed securities and about US$175 billion of federal agency debt in March could spur an increase in mortgage rates and lead to declines in home sales and prices, Krugman said.

"Probably mortgage rates go up some," he said. "New home sales are still pretty weak and new home construction is a joke by the standards of a few years ago. But they probably falter."

The Fed should consider buying another US$2 trillion in assets to reduce unemployment, Krugman said.

Fed Chairman Ben Bernanke and his fellow policymakers cut the benchmark interest rate almost to zero in December 2008 while switching to asset purchases and credit programmes as the main policy tools. The central bank has expanded its balance sheet to US$2.24 trillion from US$858 billion at the start of 2007.

US manufacturing expanded last month at the fastest pace in more than three years, aided by government-assisted rebounds in housing and carmaking, a report from the Institute of Supply Management indicated.

Elsewhere, construction spending dropped for a seventh month, the Commerce Department said yesterday.

"Stimulus we know starts fading and goes negative around the middle of the year," Krugman said. "Inventory bounce, which is driving things right now, will fade out as inventory bounces do."

Any sales by the Fed of mortgage-backed securities as part of a so-called "exit strategy" from record stimulus could increase mortgage rates by 1 percentage point and impede the recovery, Krugman said.

The rate for 30-year fixed US home loans rose to 5.14 per cent in the week ended December 31, the fourth straight weekly increase and highest level since August, according to mortgage finance company Freddie Mac.

Krugman said he disagreed with former Fed chairman Alan Greenspan's view that the surge in stock prices last year reduces the need for additional government stimulus. The Standard & Poor's 500 Index rallied 23 per cent in 2009, its best performance since 2003.

"People are a lot poorer than they were four years ago," Krugman said. "Consumption is not that dependent on stock values, much more so on housing values."

Advanced economies in Europe and Asia also faced the risk of a renewed recession, Krugman said.

"The double dip issue is present everywhere in the advanced world," he said. "We all have stimulus programmes that kind of fade out."

The US dollar might weaken "a little bit" against other advanced country currencies, he said. "The weakening of the dollar is all good for us, not so good for the Europeans and the Japanese," Krugman said in response to questions after his speech.

At its last meeting in December, the central bank's Federal Open Market Committee said economic activity had picked up, while affirming a pledge to keep the target interest rate exceptionally low for an "extended period".

"Historically, financial crises are very, very prolonged," Krugman said. While the US banking system had stabilised, it hadn't returned to normal, he said.

"Small business is still very constrained in its borrowing," he said. "That is not a good thing. We do not have a fully healthy, functional financial system."

The economy expanded at a 2.2 per cent annual rate in the third quarter.

The nation's jobless rate stood at 10 per cent in November, up from 9.8 per cent in September. The rate will probably rise to 10.1 per cent in December, according to the median estimate in a Bloomberg News survey of economists ahead of the Labour Department's report at the end of this week.

- BLOOMBERG