What does it take to slow a speeding economy?

Alan Greenspan

and other

Federal Reserve

policymakers are searching for the answer.

The government reported Friday that the

gross domestic product

grew at a staggering rate of 5.8% during the fourth quarter, and that the cost of hiring workers and keeping them happy was sharply on the rise.

That adds to other recent signs that the American economic boom -- just days away from becoming the all-time longest period of prosperity for the U.S. -- may be getting unwieldy, even though consumer inflation has yet to show signs of becoming widespread.

Still, the seeds of inflation look set to germinate, given the ever-shrinking pool of workers, growing consumer appetites related to wealth created by the stock market, and surges in the price of oil. As such, the Fed is finding itself in a position of having to curb those potentially inflationary forces while at the same time insuring that steady economic growth will continue.

The Fed will probably do that by raising interest rates next week. But it remains to be seen whether an expected increase of a quarter percentage point in short-term rates will be adequate.

Higher rates usually curb growth by making it harder for businesses and consumers to borrow and spend. Indeed, the Fed raised short-term rates three times last year by a total of three-quarters of a percentage point. But given the dizzying pace of the economy in the fourth quarter, it's almost as if rates had never been raised at all.

Beside the 5.8% GDP reading, the government's

employment cost index

, a measure of wages and benefits for workers, rose at a faster-than-expected 1.1% pace in the fourth quarter, compared with 0.8% in the third quarter. That shows that despite the sharp rise in worker productivity, employers are starting to feel the squeeze of rising wages.

"These were watershed numbers," said David Jones, chief economist at

Aubrey G. Lanston & Co.

"After three (interest rate) hikes last year, everybody had been looking for a slowdown, but we're finding that no such thing happened, and in fact, some areas such as wages and benefits are accelerating."

The Fed is clearly worried that the unprecedented strength is threatening to run the economy into the ground, as consumer demand for goods and services threatens to outstrip supply, raising the prospect of a breakout in inflation.

Speaking to economists in New York earlier this month, Greenspan, the Fed's chairman, reiterated that the Federal Reserve's job is to extend the economic expansion by "containing its imbalances and avoiding the very recession that would complete the business cycle."

"This is an economy with impressive forward momentum, and it's clear that the Fed has a lot more work to do," said Anthony Karydakis, senior financial economist at

BancOne Capital Markets

in Chicago.

Federal Reserve policymakers will meet on Tuesday and Wednesday to discuss their next move. Most economists still expect the Fed to raise the federal funds rate -- the overnight rate at which banks borrow from another -- by another quarter percentage point., to 5.75%. This short-term rate influences most other interest rates, including those for credit cards and mortgages.

Some watchers have suggested that the Fed might move more aggressively and raise rates by half of a percentage point.

At the

Chicago Board of Trade

fed funds pit, traders who bet on the likelihood of interest rate moves are looking at a 100% chance that the Fed will raise rates by a quarter percentage point and about a 30% chance that it will increase by a half percentage point at the February meeting. They're also betting that the Fed will raise rates by a total of three-quarters of a percentage point by mid-year.

But an increase beyond a quarter percentage point next week could jolt the high-flying stock market, sending ripples through the economy.

"Greenspan clearly does not want to burst the stock market bubble," said Jones, the Lanston chief economist. "Given that inflation has not hit a dire level, the Fed has some leeway to try and orchestrate a soft landing for the economy."

In many ways, the booming stock market has allowed U.S. consumers to push the economy far past its traditional speed limit of a 3% rate of growth. That notion was confirmed by a preliminary report released Friday by the

University of Michigan

that showed that consumer confidence reached an all-time high in January.

Still, many say that the stock market will have to experience some degree of retrenchment before the Fed is satisfied that heady economic growth will settle to less worrisome levels.

"It's going to take some sort of slowing in stock market growth, and most likely a correction, to slow the economy," said William Sullivan, senior vice president at

Morgan Stanley Dean Witter

.

"The Fed has a very careful balancing act," he added. "If the stock market were to suffer a large correction, we might suddenly find that interest rates are too restrictive."