Fed official says ceiling is higher for expansion without inflation

"The most important thing in monetary policy is to avoid making monetary policy based on GDP growth," Robert McTeer, president of the Federal Reserve Bank of Dallas, told a gathering of economists. "We don't know what the speed limit is." Mr. McTeer is a member of the Fed's policy-making Federal Open Market Committee, although he is not a voting member this year.

The Fed has raised interest rates six times over the last 15 months, raising the key federal funds rate to a 9½-year high of 6.5 percent specifically to slow economic growth to a rate it considers safe. Since May, however, the Fed has avoided raising rates, acknowledging that the rate it considers safe has increased.

Mr. McTeer, speaking at the annual conference of the National Association for Business Economics, on Monday offered the most optimistic assessment of any Fed policy-maker about the maximum rate the economy can grow without sparking inflation. He suggested it may be as high as 6 percent, well above the range of 3.5 percent to 4 percent estimated by most Fed policy-makers.

Mr. McTeer said estimates of the maximum sustainable growth rate traditionally have been made by adding increases in work hours to increases in productivity. Until the 1970s, he said, the sustainable rate was estimated at 2.5 percent, because productivity gains averaged 1.5 percent and work hours grew by 1 percent. But productivity gains have since accelerated substantially.

In the year through June, for example, U.S. non-farm business productivity grew 5.2 percent, the fastest rate since 1983. If that rate is used to estimate the sustainable rate of growth, the economy could grow as much as 6 percent without sparking inflation, he suggested. "Now let's see, 5 percent plus 1 percent," he said.

Mr. McTeer, who last year dissented against Fed decisions to raise interest rates, said productivity gains are "almost certain" to be "greater than currently measured." Still, he said, productivity growth can't accelerate indefinitely and Fed policy-makers must be appropriately cautious.

"I don't suggest that we base monetary policy on productivity. I suggest that we base it on inflation and inflation indicators," Mr. McTeer said. "So I don't think we'd be thrown off with the productivity statistics."

Fed policy-makers acknowledge that the central bank no longer is trying to slow economic growth, largely because productivity data since May have mostly dispelled their fears of near-term inflation. For the next few months, they say, they will pay much closer attention to actual evidence of inflation in deciding whether further interest-rate increases are warranted.

Given that inflationary pressures remain mild, Wall Street and most economists now expect the Fed not to raise rates again for the foreseeable future. Most of the recent increase in inflation, Mr. McTeer said, is the result of higher energy prices, including oil prices, which hit a 10-year high last week. "It's possible oil prices are near their peak," he said.

Still, Mr. McTeer took economic forecasters to task for consistently being too gloomy about the economic outlook. "We all know this economy has not been kind to the pessimists," he said. "Frequently the optimists have not been optimistic enough."

He said he could see nothing in the "economic realm" that would pose a risk to U.S. prosperity. The ballooning current-account deficit, he said, isn't a cause for worry because it "reflects economic strength rather than weakness": The U.S. economy is importing more than it exports because it is growing much faster than foreign economies. Moreover, the U.S. stock market isn't quite the danger that many policy-makers thought it was earlier this year.

"If it was a bubble, it is much less of a bubble than it was at the first of the year," Mr. McTeer said.

Instead, he said, the biggest threat to long-term economic prosperity is educational. "We aren't producing nearly enough technically skilled workers" to meet the needs of the economy, he said.

He urged Congress to approve more temporary work visas for highly skilled foreign workers. In addition, he said, "I think we would benefit from immigration at the lower end."

Mr. McTeer said a tight labor market promotes increased productivity, which boosts the economy's capacity for non-inflationary growth.

Recently, he said, U.S. job growth has slowed, indicating an overall economic slowdown may be under way. But the slowdown will be gentle: "I don't expect a recession at all," he said.