Oct. 14 (Bloomberg) -- Rising rates of output per hour of work in the U.S. may eventually require higher short-term interest rates to offset the risk of rising inflation, said St. Louis Federal Reserve President William Poole, who also emphasized that the timing of rate changes is ``uncertain.'' ``There is a distinct possibility that the underlying pace of productivity growth has increased again,'' said Poole, a non- voting member of the Federal Open Market Committee, in the text of a speech at Bryant College in Providence, Rhode Island. ``If so, and if the FOMC does not make appropriate policy adjustments, inflation could drift away from the current low levels.'' Poole said rising rates could initially push inflation lower, as productivity gains enable firms to produce more goods at the same or lower costs. ``The current stance of policy makes adequate allowance offsetting the risk that the current low inflation will turn into a period of deflation,'' he said. ``And Fed vigilance over the longer run will, I believe, keep inflation under control.'' In response to questions after his remarks, Poole said he doesn't see inflation problems in the future. ``People have tremendous confidence inflation will remain low,'' he said. Consequently, an ``expectational surge'' in inflation isn't likely, and Fed policy makers ``are prepared to step on the brakes, whatever it is going to take'' to ensure that ``we maintain stable inflation.''
Sustained Growth
Poole said gross domestic product can grow at 5 percent or 5.5 percent for ``several years'' without ``putting any strains on the economy'' and spurring inflation. ``If we're growing at 5 or 5.5 percent, we're only slowly eating into the margin of unused or underutilized resources,'' Poole said in response to a reporter's question after his speech. ``That would gradually bring the unemployment rate down, gradually lead to more employment of the excess capital stock.'' The St. Louis Fed president's speech provided a detailed look at how gains in productivity, a measure of output per hour of work, may begin to influence Fed policy. Productivity showed unusually high growth of 4.8 percent over the past two years, he said. In recessions, productivity typically declines as companies are slow to fire workers amid falling demand. Productivity growth averaged about 2.5 percent a year in the second half of the 1990s, about one percentage point higher than in the previous 30 years.
`Productivity Surprise'
``Today, we're getting a productivity surprise on the upside, and of course that's why we don't see any employment growth,'' Poole said in response to questions. ``The GDP advance has been pretty good, but it's all been accounted for by rising output per worker.'' ``I think we're on the course for higher GDP growth and employment growth, although I don't know exactly when it's going to start,'' Poole said. The U.S. ``will have sustained job increase, but I don't know when it will start.'' Rising rates of productivity increase the demand for capital; as a result, the Fed has to keep interest rates at a level that will inspire people to save. ``It is hard to ignore the fact that at a one-year maturity, the real rate of interest is about zero today,'' said Poole, referring to the 1.22 percent average implied yield on a 1-year Treasury note during the third quarter. ``That rate, I believe, should be viewed as a transitory situation during the process of economic adjustment reflecting fundamental longer-term forces. Among these fundamental forces, the rate of productivity growth is certainly at the top of my list.''
`Timing Uncertain'
Poole said the Fed should try to mitigate short-run disturbances to the economy, as it has in the past two years by cutting interest rates 13 times as output and investment spending fell in the wake of the Sept. 11, 2001, terrorist attacks and the declines in stock prices. Still, ``as important as short-run policy adjustments are, if the FOMC focuses only on transitory disturbances and fails to understand the longer-run forces, it runs the risk of falling behind as the economy converges toward its balanced growth path,'' said Poole. If long-run productivity rates settle at 3 percent, ``a reasonable guess on the equilibrium real rate of interest is about 4 percent.'' The St. Louis Fed president said the ``timing of interest rate changes is highly uncertain.'' After his remarks, Poole was asked about Fed policy in relation to the decline of the dollar against other currencies. ``We obviously have to take account in our policy of the expected effects of exchange rate changes,'' Poole said. ``Exchange rates are highly visible, but the magnitude of the effects on the U.S. economy are perhaps much less than you might think, particularly in the short run from exchange rate changes.'' //www.bloomberg.com