"How fast can the economy safely grow?" asked Edward W. Kelley Jr., one of the seven members of the board of governors of the Federal Reserve, who was last Wednesday the guest speaker of the Florida international bankers association and the Miami bond club. It was the first speech of a Federal reserve board official after Alan Greenspan spoke on January 16.
"There are only two elements in growth : labor force and productivity. With a demographic growth of 1% a year and a long term productivity trend of 1% improvement a year, sometimes more or less, the potential growth in the economy is 2% may be as high as 2.5%." He said a growing number of economists think the US can sustain 3% growth"but I haven't heard we can sustain any higher than 3%. Labor participation is rising and productivity is improving. I have a lot of sympathy" for these theories" but I will say it's 3%, not 3.8% growth compatible".

The Asian economic crisis impact on the US economy will "knock-off half a percent to one percentage point of growth, which is a kind of welcome because growth was very strong in 1997 and so far in 1998. We can't go indefinitely at that rate. If it has a lesser impact than that, we're looking at a very strong growth rate and we'll have to be concerned," Mr. Kelley said after emphasizing that the "essential pre-condition" to get the maximum economic growth "is price stability" as "inflation induces series of boom-bust cycles." On the other hand, "I do not believe deflation is a threat in this economy," Mr Kelley said. "One can not foresee a deflation in the US."

Inflation below 5% unemployment
"There are two key drivers of the monetary policy," said Mr. Kelley. "Inflation arise in overheated economy when the aggregate demand exceeds the aggregate supply. A big concern today is that the labor market is very very tight." Mr Kelley also said that the best people who had worked on the theory of non-inflationary rate of unemployment "still think it's 6% today" even if "some say it's 5.5%. But I haven't heard anybody saying the non-inflationary rate of unemployment is 5% or less. If there is such a thing that works, we're under," Mr Kelley added. The second driver is that "monetary policy changes," Mr Kelley said "don't impact the economy before six, twelve or even twenty four months." Which is the reason the Fed interest rates policy "cannot avoid to be preemptive."

In other words, it means that the Fed would have to consider rising interest rates to slow the economy in a preemptive manner if it thought the growth was too strong. And that's apparently what Mr. Kelley thinks it is.