U.S. Faces Stagnation Period Until Budget Cuts, Fed Adviser Prescott Says

The U.S. economy is likely to experience a period of stagnation until the country reduces its debt, according to Edward Prescott, senior monetary adviser to the Federal Reserve Bank in Minneapolis.

“I wouldn’t be surprised if we had some subtrend economic growth” until reforms are instituted to reduce public expenditure and boost productivity, Prescott, a recipient of the 2004 Nobel Prize for economics, said at an interview in Shanghai. “I’m hoping the U.S. doesn’t follow the Japanese in their decade of lost growth.”

Japan’s so-called lost decade was a period during the 1990s in which the economy slipped in and out of recession and grew at an average rate of about 1 percent a year after the collapse of a real-estate bubble.

U.S. unemployment near 10 percent and a record 27 percent plunge in sales of existing homes in July are also increasing the risk of a renewed recession in the world’s largest economy. Mohamed A. El-Erian, chief executive officer at Pacific Investment Management Co., estimated the possibility of deflation and a double-dip recession in America at 25 percent.

The U.S. economy grew at a 1.6 percent annual pace in the second quarter, exceeding the median forecast of economists surveyed by Bloomberg News and down from an estimate of 2.4 percent issued last month, according to revised figures from the Commerce Department.

The risks of a contraction have grown due to a spate of disappointing data, said Lyle Gramley, a former Fed governor who’s now a senior economic adviser for the Potomac Research Group in Washington. The unemployment rate probably rose to 9.6 percent this month from 9.5 percent in July as employers reduced payrolls by 100,000, according to the median forecasts of more than 70 economists surveyed by Bloomberg News.

“I would be very surprised if we see a sharp drop-off in growth,” said Prescott, who is professor of economics at Arizona State University.

--Chua Kong Ho in Shanghai. Editors: Allen Wan, Linus Chua

To contact the Bloomberg News staff for this story: Chua Kong Ho in Shanghai at kchua6@bloomberg.net

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