Updated at 7.22pm: Hong Kong's economy is troubled but can cope with deflation and sustain the currency's peg to the US dollar, economist Paul Krugman said. ''I've seen crisis economies and this is not a crisis economy,'' the Princeton University professor said today. The Government was doing all it could to counter the economic downturn but was hampered by the fixed exchange rate, which meant ''it has no monetary policy, only fiscal policy, which can only do so much''. ''Hong Kong is better able to deal with deflation than most countries,'' Mr Krugman said. ''It's got relatively flexible prices, it doesn't have a lot of foreign debt, it's not leveraged.'' Consumer prices in the SAR have been falling for three years, registering a year-on-year drop of 1.2 per cent in October. The Government said yesterday it expected the composite consumer price index to drop 1.6 per cent for the full year, lowering its forecast from 1.3 per cent previously. Mr Krugman said deflation was not good, but was not ''a life or death issue'' for Hong Kong. ''The other currency board experiencing deflation is Argentina, and you would certainly much rather be Hong Kong than Argentina. Hong Kong can live like this for years. Argentina just hit the wall,'' he said. ''I've been to Argentina not long ago. We're talking 5 per cent unemployment versus 20 [per cent], we're talking a massive creditor economy versus an economy which is defaulting on its foreign debt.'' By comparison with Argentina, Hong Kong was ''low-grade stuff'', he said. ''This is not an economy in depression but it's a troubled economy.'' Mr Krugman said Hong Kong should be able to maintain the currency peg unless a sharp depreciation in the Japanese yen - which he saw as a real possibility - forced its hand. ''You can think about what it might look like in two years if the yen is at 180 and the renminbi's been devalued. That would be a very interesting thing. You might want to rethink the peg at that point,'' he said. ''There's a scenario [which] might come true, which is a big devaluation of the yen, triggering a domino effect throughout Asia. In that circumstance, the fixed rate of the Hong Kong dollar to the US dollar is going to look hard to sustain.'' This would be a repeat of the situation during the Asian crisis in 1998, when the Government intervened in the stock and futures markets to beat back speculators betting that the peg would be broken. ''We thought we might be there back in 1998. That was what people feared and in fact it didn't happen, but maybe that was just a postponement,'' Mr Krugman said. ''I think the hedge funds [which speculated against the Hong Kong dollar] aren't there anymore, but the story is still a possible one.'' If there was a big rebound in the global economy next year, Asia could rebound strongly as it did after 1998, Mr Krugman said, adding: ''I'm not betting on it, but that could happen.'' The peg's future has been the subject of debate this year, after Financial Secretary Antony Leung Kam-chung said in August that the fixed exchange-rate link was an ''obstacle'' to economic recovery. Chief Secretary Donald Tsang Yam-kuen vowed again on Thursday the Government would stick by the peg. Mr Krugman said that, eventually, the peg would go. ''Some day, in the long run, the dollar peg doesn't make sense.'' In the short run, it would not make sense to peg the dollar to the renminbi because the Chinese currency was not convertible. ''Maybe five years from now, China will be a convertible currency and Hong Kong will simply join it. Maybe not. Hong Kong is a bigger economy than New Zealand. It could have a floating exchange rate. There are lots of possibilities out there.'' Mr Krugman made his remarks after delivering a lecture on ''Lessons from Japan's Depression'' at the Chinese University of Hong Kong. The influential economist - often cited as a potential future Nobel Prize winner - is known for advocating that the Japanese central bank print yen to create inflationary expectations and thereby pull the country out of its deflationary ''liquidity trap''. He said there were few parallels between Japan's situation and Hong Kong: ''I think Hong Kong is basically too open to have a real liquidity trap.''