WASHINGTON -- Federal Reserve Board Chairman Alan Greenspan is rummaging around in his public relations toolbox to come up with a new rationale for raising interest rates.

Greenspan and his colleagues have known since their May 17 move boosting the federal funds rate to 4.25% from 3.75% that they can't keep on using the old spin about moving to a neutral policy on rates.

The new buzzword coming out of the Fed is productivity, which measures how much labor businesses require to produce goods and services. Typically, businesses seek to boost productivity by investing in plant and equipment, restructuring their workforce, and doing whatever else they can to become more efficient.

Since 1990, U.S. productivity has increased by about 2% a year, but economists say some of that is the result of gains that typically occur in an upturn as businesses increase output while they hold back hiring. Many estimate that growth in long-term productivity is running at about 1.5% a year.

To calculate how fast the economy can grow without overhearing and stirring up inflation, economists add up productivity and labor force growth. The Bureau of Labor Statistics projects that the labor force will grow 1.3% a year between now and the year 2005.

Assuming a productivity growth rate of 1.5% and labor force growth of 1.3%, economists get a GDP growth rate in the 2.5% to 3% range. Analysts work with slightly different numbers, but anything above that range signals an overhearing economy generating wage and price pressures.

In March, Greenspan said that the underlying trend in U.S. productivity growth was running at around 1.5% -- a conventional estimate. The figure was contained in a speech Greenspan was scheduled to make in Dallas but had to cancel when he was summoned to the White House by President Clinton for one of their private chats. Fed officials nonetheless distributed the text of the speech.

But in testimony last week to the House Budget Committee, Greenspan suggested that productivity gains may now be running higher as businesses reap the gains of the computer age.

"There are some signs of improvement in our underlying productivity performance in response to increased global and domestic competition and improved management. In addition, the investment in high-tech equipment now finally appears to be paying off," Greenspan said.

Gains in productivity are a wonderful thing, Greenspan explained. He called productivity "the key to increase our standard of living over time" because it allows businesses to raise wages without kindling inflation. Moreover, he said, there is increasing evidence that lower rates of inflation can bring not only higher levels of productivity, but faster growth in productivity.

Under the new Fed jargon, rate hikes can be justified because in suppressing inflation they boost productivity of U.S. businesses, which in turn are supposed to pass the gains on to workers in the form of higher real wages.

Whether Fed officials actually raise rates further remains to be seen. Many analysts on Wall Street believe they will, especially if the economy keeps growing faster than 3% in the second half of the year. But if that happens, Greenspan will be telling the public about how he is doing good things for the economy even as the Fed chips away at jobs in interest-rate sensitive sectors like homebuilding and autos.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.