All eyes are now on the Federal Reserve’s next policymaking meeting on May 16th. Will Alan Greenspan and his colleagues raise interest rates by half a percentage point, abandoning their current strategy of gradually tightening monetary policy in quarter-point increments? Most economists reckon that they will. The real issue, however, is more fundamental. Is the extraordinary American expansion of the 1990s at risk of ending in the good old-fashioned way, with spiralling inflation forcing a hard landing?

The answer to that question depends on three more questions. How strong is today’s inflationary pressure, and how quickly is it likely to intensify? And will the economy slow down fast enough to dampen price pressure without tipping into recession?

The evidence for inflationary pressure is now unambiguous. Consumer prices rose 3.7% in the year to March. Even excluding the volatile categories of oil and food, “core” consumer prices rose 2.4%, roughly one half of a percentage point faster than in 1999. The GDP price deflator rose by 2.7% in the first three months of 2000, up from 1.2% in the middle quarters of 1999.

Some aspects of March’s nasty inflation surprise might be “one-offs”: tobacco prices, for instance, were affected by a tax increase in New York state. Nonetheless—and modest as they may be—there are broad-based upward trends. Over the past six months, prices of services—from health care to hotel rooms—have risen at an annualised rate of 3.6%, almost a percentage point faster than in the previous year.

More important for longer-term price pressure, labour costs are also rising. The employment-cost index, perhaps the most widely watched gauge of wage pressure, rose 4.3% in the year to March, its biggest jump for more than eight years. Rising wages and higher benefit costs both fuelled the increase. For workers in private industry, wages and salaries rose 4.2% in the year to March, while overall benefit costs were up 5.5% over the year before. Health benefits, in particular, have risen sharply. In another recent report, the Minneapolis Federal Reserve noted that health-care costs in Minnesota were up 10-12% from a year ago. The downward nudge that low benefit costs gave to wage figures seems to be over.

That America’s super-stretched labour market is finally producing accelerating wages is hardly a surprise. The unemployment rate fell to 3.9% in April, the lowest level since 1970 and the lowest peacetime level since 1957. Although it is a brave economist who actually puts a number on where the “natural” rate of unemployment might be today, it is almost certainly higher than 3.9%. Nor does the tight labour market show any signs of letting up. Part of the jump in employment was caused by the temporary hiring of hundreds of workers for the census. But even excluding that, over 256,000 new jobs, on average, have been created every month for the past six months. That is substantially more than the already strong monthly average of 230,000 a year ago. Almost 65% of Americans aged 16 and over are now employed, a record high. And every measure of joblessness is at record lows: unemployment rates for blacks and Hispanics, for instance, have hit their lowest level since records began.

With a labour market this tight, wage pressure is likely to keep building up. It may do so gradually, but it will be persistent. To what extent higher wage pressure will fuel inflation depends on productivity growth. In the second half of 1999, productivity grew so fast that it more than made up for rising wages. Unit labour costs actually fell. Recent evidence suggests that this trend may be reversing. American workers’ output per hour rose by an annualised 2.4% in the first three months of 2000, well below the 6.9% rate of productivity growth in the final quarter of 1999. As a result, unit labour costs rose 1.8% in the first three months of this year.

Admittedly, this is still a modest rise, well below the rate of inflation. Compared with a year ago, unit labour costs have risen a tiny 0.7%. And it is important not to exaggerate the impact of one quarter’s figures. Nonetheless, it seems that productivity growth is slowing while employment costs are accelerating. Economists at Goldman Sachs expect unit labour costs to accelerate to 3.2% by the end of the year. At those levels, more inflationary pressure will be inevitable.

To reduce the risk of a wage-price spiral, the labour market needs to calm down. And in order for unemployment to rise a bit, the economy clearly needs to cool off: not just to its sustainable rate of growth, but quite possibly below that for a while. For only if the economy grows below trend will unemployment begin to edge up again. Again, accelerating productivity means that no one knows exactly where America’s sustainable growth rate now lies. But it is certainly below the annualised 7.3% by which the economy grew during the last three months of 1999, and below the 5.4% it grew in the first three months of this year. A more plausible (but still highly uncertain) guess is that America’s sustainable rate of growth now lies between 3.5% and 4%.

Can the economy slow to that level, and beyond, without a hard landing? So far, it is hard to see much evidence of serious slowdown. In many ways, the first quarter’s GDP estimates understate just how much demand has been booming. A huge trade deficit and drops in inventory dragged down overall GDP growth, even though overall consumption grew by a staggering 8.3% at an annual rate, and investment in equipment and software soared almost 24%, as companies stopped worrying about Y2K problems.

This rip-roaring rate is unlikely to continue. The post-Y2K effect will not recur. And much of the consumption boom was probably due to the exceptionally mild winter, which may have induced people to spend more than they might normally have done. Some statistics are still strong: April sales of new houses were firmer than expected. But retail sales unexpectedly fell in the same month. Nonetheless, given that exports are likely to rise in today’s more vibrant global economy, and that inventories will need to be built up, GDP growth in the second quarter of 2000 could still be well over 4%.

To achieve a sustained slowdown, interest rates clearly need to rise. But by how much? Financial markets have priced in a high probability of short-term rates rising a full percentage point, to 7%, this year. Some analysts expect an even more aggressive tightening. Economists at JP Morgan, for instance, now forecast that the federal funds rate will reach 7.25% by August, which implies a total rise of 1.25% in only four months. That kind of rapid tightening may well not happen, but it is not unprecedented. In 1994, Mr Greenspan raised short-term interest rates by 1.5% in a matter of months. Quite plausibly, rates could rise enough to slow down the economy sufficiently without bringing on a calamity. But once a boiler has started steaming, it is certainly hard to carry on boosting it without blowing it up.