If Business Week seems not to understand the speedometer logic of productivity and growth, it is equally clueless when it comes to the similar logic of productivity and inflation.

The measure of inflation that most macroeconomists prefer is not the somewhat screwed-up Consumer Price Index but the so-called GDP deflator. This is defined as the difference between the growth rates of nominal and real GDP. If the dollar value of production in the United States rises 5 percent, while real GDP is estimated to have risen only 3 percent, then the GDP deflator is said to have increased by 2 percent. And in fact inflation as measured by the GDP deflator has been stable at about 2 percent lately, despite what appears to be a very fully employed economy. This is the happy mystery of recent U.S. prosperity.

Can unmeasured productivity growth explain this mystery? At first sight it might seem to be a possible answer. Suppose that wages are rising by 4 percent per year and productivity by 1 percent. Then other things being the same, you might expect prices to rise by about 3 percent; but if productivity growth were 2 percent instead of 1 percent, you would expect inflation of only 2 percent. So faster productivity growth could mean lower inflation.

But suppose that the U.S. economy is in fact experiencing 1-percent faster productivity growth than the official statistics say. As we have already seen, such understatement of productivity growth must mean that the true rate of real growth is 1 percent higher than the official rate. And since nobody claims that we are mismeasuring the dollar value of output, this must mean that the true rate of inflation is 1 percent less than the official rate, that is, 1 percent rather than 2 percent. So while invoking hidden productivity gains explains why inflation might be lower than we would otherwise expect, for every percentage point of explanation it also adds a percentage point of extra mystery, leaving us no closer to an answer. Or to put it differently, unmeasured productivity growth gets us precisely nowhere in explaining a low measured rate of inflation.

But then what is the answer? The main point is that labor costs are actually not rising very fast. Over the last year, the compensation (wages plus benefits) of the average worker rose only about 3 percent. With compensation rising 3 percent and productivity 1 percent, price inflation of 2 percent is no puzzle; it's just what you would expect. (Incidentally, Business Week has argued that real wage growth--wage increases minus inflation--should be higher, given the economy's hidden productivity growth. Apparently it does not understand that if there is hidden productivity growth, actual inflation is lower than measured, and hence workers already are getting higher real wage increases.)

The only serious question is why wage growth has remained so sluggish in what appears to be a hot job market. One answer is that wage growth actually is accelerating--average wages have risen more than 4 percent over the past year--but overall labor costs have been held down by a squeeze on benefits, mainly as the result of the switch to managed health care. This is presumably a one-time event, one of a number of lucky events that have helped keep inflation down. Good luck has a way of running out; stay tuned.

Another answer is that there really is a new economy, but it is not very nice. In America 1997 it is easy to find a job, but it is also easy to lose one. Perhaps the decline of unions, the rise of downsizing, and the growing use of temporary workers all mean that 4.6-percent unemployment just isn't what it used to be. On this view, the secret of our success is not productivity but anxiety.

Either way, there is nothing in the actual situation to suggest that the U.S. economy is capable of achieving a growth rate as measured by GDP of more than 2.5 percent over, say, the next five years. Of course, we could always have a happy surprise. For example, the good news on productivity this year could turn out to be the start of a trend rather than a statistical blip--unlike the even bigger productivity blips in 1984 and 1992. But as Margaret Thatcher once asked, why do people always expect surprises to be favorable?