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Business and Wall St. Eye the Fed

Outlooks differ on how fast the US economy can grow without inflationary problems

HOW fast is fast? What's the speed limit for the United States economy? Should everyone have a job who wants a job?

These are the economic questions du jour, as President Clinton unpacks from his trip to Europe commemorating the 50th anniversary of D-Day.

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The president, who returned home on Wednesday night, will find swarms of Democrats who are unhappy to see the Federal Reserve trying to slow down the economy. And he will find business and the stock market nervously watching to see if rates will go up again within the next month.

Economists admit that hardly anyone knows how fast the US economy can safely run without emitting an inflationary byproduct. ``We don't know the growth potential,'' says Robert Dederick, chief economist at Northern Trust Company in Chicago.

The commonly accepted potential real- growth rate is thought to be 2-1/2 percent to 3-1/2 percent a year. ``I would argue it is dangerous to get more precise - we just don't know it well enough,'' maintains Charles Plosser, dean of the University of Rochester's William Simon Graduate School of Business in Rochester, N.Y.

Some economists, however, believe the potential growth rate should be lower or higher. For example, Alan Blinder, Mr. Clinton's nominee for Federal Reserve Board vice chairman, says the economy is still operating below its potential. Economic data indicate the economy is starting to slow down from a 3.5 percent annual pace.

According to Fed-watcher Bruce Steinberg, an economist at Merrill Lynch, Fed Chairman Alan Greenspan believes the economy can grow at a real 2.8 percent annual pace without inflationary problems. Mr. Steinberg contends that the economy has room to grow at a faster pace.

The issue is not academic. ``It is a major issue at the Federal Reserve Board, with the majority view that we are close to full employment,'' says David Hale, chief economist at Kemper Financial Services Inc. in Chicago.

Mr. Hale says the Fed has watched as the labor force has grown by about 150,000 workers each month. During some months, however, the demand for new workers has reached as high as 250,000. The result, Hale maintains, is labor shortages in the Midwest and Southeast, both economically strong areas.

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Labor Secretary Robert Reich says the improved labor numbers mean that high school and college graduates will face one of the best job markets in years.

THE latest unemployment rate, issued last Friday, dropped from 6.4 percent to 6 percent. Employment only grew moderately, however.

``We are probably close to full employment, although no one can know the precise number,'' says Charles Schultze, an economist at the Brookings Institution in Washington and a former chairman of the Council of Economic Advisers.

On May 27, Sen. Jim Sasser (D) of Tennessee told Mr. Greenspan that he felt the Fed's tight monetary policy ``not only jeopardizes job restoration, but wage restoration as well. Now, when working Americans might get their first benefits of the economic expansion, the Federal Reserve is hitting the brakes.''

Many members of Congress have written Greenspan, questioning the 1.5 percent interest rate rise since January.

Although the Fed does not disclose its internal discussions for some time, Greenspan has talked about the economy growing beyond its potential as the rationale for the rate hikes.

The Fed, in a staff study released on Wednesday, suggests that its hikes in interest rates are justified to keep inflation low, so productivity rises. The Fed reasoned that the higher productivity, which would increase gross domestic product by a small amount, would offset any jobs lost because of higher interest rates.

Economists have traditionally figured the economy's potential by looking at the growth rate of the working-age population and then combining that number with the productivity rate.

With the labor force growing at around 1 percent a year and the increase in productivity about 1 percent to 1.5 percent each year, economists estimate that the economy can grow at 2.5 percent without inflationary pressures.

One reason why some economists wonder if the economy might grow faster without inflation is the high level of capital spending by business. Many US companies are not just expanding, they are investing in productivity-saving machines. ``Over the last two to three years, productivity has been higher than it has been for quite a while,'' Dean Plosser says. This investment could give the economy some more slack - perhaps raising its speed limit.

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