Krugman warns ECB about getting stuck in Japan-like scenario

SINTRA, Portugal Tue May 27, 2014 7:32am EDT

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SINTRA, Portugal May 27 (Reuters) - Nobel Prize-winning economist Paul Krugman challenged the ECB on Tuesday to act to stop the euro zone slipping into Japan-style deflation, saying it risked sitting still while the economy became "persistently depressed".

Speaking at the ECB's inaugural Forum on Central Banking, Krugman suggested the euro zone could sleep walk into Japan-style deflation - a challenge to which European Central Bank President Mario Draghi will have an opportunity to respond to at the conference in Portugal later on Tuesday.

It would be easy to convince oneself there is no problem, Krugman said, adding: "There is not that explosive downward dynamics in the euro area, or in the United States.

"But then there has never been explosive downward dynamics in Japan either, and yet we do think that Japan has had a persistent deflation problem."

The ECB is getting increasingly uncomfortable with the euro zone's persistently low inflation, which has been stuck in what Draghi has called the "danger zone" below 1 percent for seven months.

Opening the ECB's Sintra Forum, billed as the European version of the Federal Reserve's renowned Jackson Hole conference, Draghi said on Monday that there was a risk of disinflationary expectations taking hold.

His comments came after he said at the ECB's May meeting that the Governing Council was "comfortable with acting next time" - its June 5 policy meeting - but wanted to see updated economic projections from the bank's staff first.

Since then, data has confirmed a slight increase in euro zone inflation in April to 0.7 percent, from 0.5 percent the previous month, but also shown that the economy grew much less than expected at the start of the year.

Krugman said a fully fledged deflation was very rare.

"If you are only going to get really ... compelled to do something when it turns into a 1933-type deflationary spiral, you are not going to get that and yet you are going to be sitting there with an economy that is persistently depressed, because inflation is too low," he said.

He renewed his call for central banks to target a higher inflation rate than, for example, the ECB's goal of just below 2 percent, to avoid getting trapped in a period of low inflation.

Olivier Blanchard, the International Monetary Fund's chief economist, had suggested a 4 percent target.

The ECB is preparing a package of policy options for its June meeting, sources have told Reuters, including cuts in all its interest rates and targeted measures aimed at boosting lending to small- and mid-sized firms (SMEs).

Five people familiar with the measures being prepared have detailed plans involving a potential rate cut, including the ECB's deposit rate going negative for the first time, along with the targeted measures aimed at boosting lending to SMEs. (Reporting by Eva Taylor; Editing by Ruth Pitchford)

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