With the IT revolution continuing and a flexible U.S. economy operating in a more global marketplace, I expect labor productivity to grow by around 2-1/4 percent per year. These estimates imply a potential for output growth of about 3 percent per year on a sustained basis.

Some may see the trend toward output growth of 3 percent as a failure of policy. But if the estimates [of labor productivity] above are correct, it is not. The economy must be allowed to move along its path of potential growth if we are to achieve monetary policy’s dual mandate of sustainable growth and price stability. Attempts to maintain consistently higher growth than this will only produce inflationary pressures and erode the price stability that is monetary policy’s most important contribution to macroeconomic stability.

According to the Blue Chip consensus, GDP is expected to grow by 3.5 percent in 2005 and by 3.3 percent in 2006—numbers on the high side of recent estimates for potential.  

As a central banker, it makes sense to me that lower and more-stable inflation, by making the returns to saving and investment more predictable and by diminishing the likelihood of shocks to the financial system, should encourage economic growth.

Studies have shown that adjustments by households and businesses in response to higher energy prices reduce the long-run level of potential output in the economy. This reduction mainly reflects the tendency of production to become more labor intensive in response to the increase in the relative price of energy. In essence, labor productivity grows more slowly after an energy price shock and that effect lowers the trajectory for potential output. If higher energy prices induce scrappage of parts of the business capital stock, this would lower the growth of capital services and further lower the path for potential output.

The nation's output growth has averaged about three and one-half percent over the past year, a rate that is moderately above trend, which is now probably around three to three and a quarter percent....This growth has been achieved in the face of some significant drags on economic activity—a growing trade gap, a very cautious environment around business investment, and, of course, high oil prices.

Maintaining confidence in sustained price stability is crucial to fostering the most productive saving and investment decisions. In addition, it affords the Federal Reserve considerably more latitude to take short-run policy actions to help stabilize economic growth...[but] it cannot in and of itself force stronger growth than the economy is capable of delivering. Trying to push an economy beyond its potential may temporarily accelerate growth, but it also creates imbalances and increases inflationary pressures that must be addressed, and so boom leads to bust.

I should note that the course of aggregate demand is not independent of the course of potential aggregate supply. Both economic theory and empirical evidence suggest that households and businesses make decisions about spending with an eye to future incomes and sales, so that a rosier long-term outlook tends to raise demand today. Thus, as the FOMC notes frequently in its statements, robust underlying growth in productivity is providing ongoing support to economic activity...

As with the transition in demand, the transition to less-spectacular growth of potential supply involves important risks. We have been persistently surprised by the extent of the pickup in productivity and could be facing a higher level and growth rate of productivity than many expect. If we are so fortunate as to be confronting these circumstances, policymakers will need to be alert to the need for a faster expansion of aggregate demand to match the stepped-up pace of supply. Conversely, perhaps the transitory factors boosting productivity will recede more sharply than most observers anticipate, and the output gap will close more rapidly. It appears to me that uncertainty in our current situation is at least as great for potential output as it is for demand.