January 30, 2002

Fed leaves the Federal Funds rate Unchanged at 1.75 percent.

-- Markets react positively to the news - Dow closing up 144.62 on the day --

The Federal Reserve elected to leave short-term interest rates unchanged at its January 30th meeting suggesting that signs of strength and expectations of a stronger economy as we move forward toward spring offset other indications of continued weakness. The Federal Reserve announced a bias towards weakness, indicating that the Fed is ready to cut rates again if the economy fails to respond more favorably in the coming months. The Fed's next meeting is scheduled for March.

January 30, 2002

The Commerce Department initially estimates that the U.S. economy as measured by the Gross Domestic Product (GDP) grew at an unexpected rate of 0.2 percent in the fourth quarter of 2001. Most analysts had expected the measure to come in at a negative rate - thereby marking the second consecutive decrease in GDP and confirming that a "recession" was underway. Varying opinions are being offered about the latest GDP number. One such opinion being espoused is that the end of the "recession" may have occurred in the 4th quarter 2001. We have serious doubts, given the deteriorating jobs environment. Albeit, consumers remain surprisingly optimistic about future economic conditions with their willingness to continue spending patterns. Durable goods orders rose by 2.0 percent in December to $176.4 billion, following a revised 6.0 percent decline in orders during November - according to the Commerce Department. Likewise, New Home Sales surged 5.7 percent in December despite the downturn. A record 900,000 new homes were sold in 2001.

The markets await the Fed's decision on interest rates later today. Consensus appears to believe that the Fed will leave short-term rates unchanged. Meanwhile, equity markets remain under selling pressure in front of the Fed's announcement.

January 29, 2002

Here is President George W. Bush’s State of the Union address, as delivered to Congress on Tuesday, January 29, 2002.

Mr. Speaker, Vice President Cheney, Members of Congress, distinguished guests, fellow citizens:

As we gather tonight, our Nation is at war, our economy is in recession, and the civilized world faces unprecedented dangers. Yet the state of our Union has never been stronger.

We last met in an hour of shock and suffering. In four short months, our Nation has comforted the victims... begun to rebuild New York and the Pentagon... rallied a great coalition... captured, arrested, and rid the world of thousands of terrorists... destroyed Afghanistan’s terrorist training camps... saved a people from starvation... and freed a country from brutal oppression.

The American flag flies again over our embassy in Kabul. Terrorists who once occupied Afghanistan now occupy cells at Guantanamo Bay. And terrorist leaders who urged followers to sacrifice their lives are running for their own.

America and Afghanistan are now allies against terror... we’ll be partners in rebuilding that country... and this evening we welcome the distinguished interim leader of a liberated Afghanistan: Chairman Hamid Karzai.

The last time we met in this chamber, the mothers and daughters of Afghanistan were captives in their own homes, forbidden from working or going to school. Today women are free, and are part of Afghanistan’s new government, and we welcome the new Minister of Women’s Affairs, Doctor Sima Simar.

Our progress is a tribute to the spirit of the Afghan people, to the resolve of our coalition, and to the might of the United States military. When I called our troops into action, I did so with complete confidence in their courage and skill — and tonight, thanks to them, we are winning the war on terror. The men and women of our armed forces have delivered a message now clear to every enemy of the United States: Even seven thousand miles away, across oceans and continents, on mountaintops and in caves — you will not escape the justice of this Nation.

For many Americans, these four months have brought sorrow, and pain that will never completely go away. Every day a retired firefighter returns to Ground Zero, to feel closer to his two sons who died there. At a memorial in New York, a little boy left his football with a note for his lost father: “Dear Daddy, Please take this to Heaven. I don’t want to play football until I can play with you again someday.” Last month, at the grave of her husband, Micheal, a CIA officer and Marine who died in Mazar-e Sharif, Shannon Spann said these words of farewell: “Semper Fi, my love.” Shannon is with us tonight.

Shannon, I assure you and all who have lost a loved one that our cause is just, and our country will never forget the debt we owe Micheal and all who gave their lives for freedom.

Our cause is just, and it continues. Our discoveries in Afghanistan confirmed our worst fears, and show us the true scope of the task ahead. We have seen the depth of our enemies’ hatred in videos where they laugh about the loss of innocent life. And the depth of their hatred is equaled by the madness of the destruction they design. We have found diagrams of American nuclear power plants and public water facilities... detailed instructions for making chemical weapons ... surveillance maps of American cities, and thorough descriptions of landmarks in America and throughout the world.

What we have found in Afghanistan confirms that — far from ending there — our war against terror is only beginning. Most of the 19 men who hijacked planes on September 11th were trained in Afghanistan’s camps — and so were tens of thousands of others. Thousands of dangerous killers, schooled in the methods of murder, often supported by outlaw regimes, are now spread throughout the world like ticking time bombs — set to go off without warning.

Thanks to the work of our law enforcement officials and coalition partners, hundreds of terrorists have been arrested… yet tens of thousands of trained terrorists are still at large. These enemies view the entire world as a battlefield, and we must pursue them wherever they are. So long as training camps operate, so long as nations harbor terrorists, freedom is at risk... and America and our allies must not, and will not, allow it.

Our Nation will continue to be steadfast, and patient, and persistent in the pursuit of two great objectives. First, we will shut down terrorist camps, disrupt terrorist plans, and bring terrorists to justice. And second, we must prevent the terrorists and regimes who seek chemical, biological, or nuclear weapons from threatening the United States and the world.

Our military has put the terror training camps of Afghanistan out of business, yet camps still exist in at least a dozen countries. A terrorist underworld — including groups like Hamas, Hezbollah, Islamic Jihad, and Jaish-i-Mohammed — operates in remote jungles and deserts, and hides in the centers of large cities.

While the most visible military action is in Afghanistan, America is acting elsewhere. We now have troops in the Philippines helping to train that country’s armed forces to go after terrorist cells that have executed an American, and still hold hostages. Our soldiers, working with the Bosnian government, seized terrorists who were plotting to bomb our embassy. Our navy is patrolling the coast of Africa to block the shipment of weapons and the establishment of terrorist camps in Somalia.

My hope is that all nations will heed our call, and eliminate the terrorist parasites who threaten their countries, and our own. Many nations are acting forcefully. Pakistan is now cracking down on terror, and I admire the strong leadership of President Musharraf. But some governments will be timid in the face of terror. And make no mistake about it: If they do not act, America will.

Our second goal is to prevent regimes that sponsor terror from threatening America or our friends and allies with weapons of mass destruction.

Some of these regimes have been pretty quiet since September the 11th. But we know their true nature. North Korea is a regime arming with missiles and weapons of mass destruction, while starving its citizens.

Iran aggressively pursues these weapons and exports terror, while an unelected few repress the Iranian people’s hope for freedom.

Iraq continues to flaunt its hostility toward America and to support terror. The Iraqi regime has plotted to develop anthrax, and nerve gas, and nuclear weapons for over a decade. This is a regime that has already used poison gas to murder thousands of its own citizens... leaving the bodies of mothers huddled over their dead children. This is a regime that agreed to international inspections... then kicked out the inspectors. This is a regime that has something to hide from the civilized world.

States like these, and their terrorist allies, constitute an axis of evil, arming to threaten the peace of the world. By seeking weapons of mass destruction, these regimes pose a grave and growing danger. They could provide these arms to terrorists, giving them the means to match their hatred. They could attack our allies or attempt to blackmail the United States. In any of these cases, the price of indifference would be catastrophic.

We will work closely with our coalition to deny terrorists and their state sponsors the materials, technology, and expertise to make and deliver weapons of mass destruction. We will develop and deploy effective missile defenses to protect America and our allies from sudden attack. And all nations should know: America will do what is necessary to ensure our Nation’s security.

We will be deliberate, yet time is not on our side. I will not wait on events, while dangers gather. I will not stand by, as peril draws closer and closer. The United States of America will not permit the world’s most dangerous regimes to threaten us with the world’s most destructive weapons.

Our war on terror is well begun, but it is only begun. This campaign may not be finished on our watch... yet it must be and it will be waged on our watch.

We can’t stop short. If we stopped now — leaving terror camps intact and terror states unchecked — our sense of security would be false and temporary. History has called America and our allies to action, and it is both our responsibility and our privilege to fight freedom’s fight.

Our first priority must always be the security of our Nation, and that will be reflected in the budget I send to Congress. My budget supports three great goals for America: We will win this war, we’ll protect our homeland, and we will revive our economy.

September 11th brought out the best in America, and the best in this Congress, and I join the American people in applauding your unity and resolve. Now Americans deserve to have this same spirit directed toward addressing problems here at home. I am a proud member of my party — yet as we act to win the war, protect our people, and create jobs in America, we must act first and foremost not as Republicans, not as Democrats, but as Americans.

It costs a lot to fight this war. We have spent more than a billion dollars a month — over 30 million dollars a day — and we must be prepared for future operations. Afghanistan proved that expensive precision weapons defeat the enemy and spare innocent lives, and we need more of them. We need to replace aging aircraft and make our military more agile to put our troops anywhere in the world quickly and safely. Our men and women in uniform deserve the best weapons, the best equipment, the best training... and they also deserve another pay raise. My budget includes the largest increase in defense spending in two decades... because while the price of freedom and security is high, it is never too high — whatever it costs to defend our country, we will pay.

The next priority in my budget is to do everything possible to protect our citizens and strengthen our Nation against the ongoing threat of another attack. Time and distance from the events of September 11th will not make us safer unless we act on its lessons. America is no longer protected by vast oceans. We are protected from attack only by vigorous action abroad, and increased vigilance at home.

My budget nearly doubles funding for a sustained strategy of homeland security, focused on four key areas: bioterrorism, emergency response, airport and border security, and improved intelligence. We will develop vaccines to fight anthrax and other deadly diseases. We will increase funding to help states and communities train and equip our heroic police and firefighters. We will improve intelligence collection and sharing, expand patrols at our borders, strengthen the security of air travel, and use technology to track the arrivals and departures of visitors to the United States.

Homeland security will make America, not only stronger, but in many ways better. Knowledge gained from bioterrorism research will improve public health... stronger police and fire departments will mean safer neighborhoods... stricter border enforcement will help combat illegal drugs.

And as government works to better secure our homeland, America will continue to depend on the eyes and ears of alert citizens. A few days before Christmas, an airline flight attendant spotted a passenger lighting a match. The crew and passengers quickly subdued the man, who had been trained by al-Qaida, and was armed with explosives. The people on that airplane were alert, and as a result, likely saved nearly 200 lives... and tonight we welcome and thank flight attendants Hermis Moutardier and Christina Jones.

Once we have funded our national security and our homeland security, the final great priority of my budget is economic security for the American people. To achieve these great national objectives — to win the war, protect the homeland, and revitalize our economy — our budget will run a deficit that will be small and short term so long as Congress restrains spending and acts in a fiscally responsible way. We have clear priorities and we must act at home with the same purpose and resolve we have shown overseas: We will prevail in the war, and we will defeat this recession.

Americans who have lost their jobs need our help and I support extending unemployment benefits, and direct assistance for health care coverage. Yet American workers want more than unemployment checks... they want a steady paycheck. When America works, America prospers, so my economic security plan can be summed up in one word: jobs.

Good jobs begin with good schools... and here we’ve made a fine start. Republicans and Democrats worked together to achieve historic education reform so no child is left behind. I was proud to work with Members of both parties... Chairman John Boehner and Congressman George Miller, Senator Judd Gregg... and I was so proud of our work I even had nice things to say about my friend Ted Kennedy. I know the folks at the Crawford coffee shop couldn’t believe I’d say such a thing... but our work on this bill shows what is possible if we set aside posturing and focus on results.

There’s more to do. We need to prepare our children to read and succeed in school with improved Head Start and early childhood development programs. We must upgrade our teacher colleges and teacher training and launch a major recruiting drive with a great goal for America: a quality teacher in every classroom.

Good jobs also depend on reliable and affordable energy. This Congress must act to encourage conservation, promote technology, build infrastructure, and it must act to increase energy production at home so America is less dependent on foreign oil.

Good jobs depend on expanded trade. Selling into new markets creates new jobs, so I ask Congress to finally approve Trade Promotion Authority. On these two key issues, trade and energy, the House of Representatives has acted to create jobs... and I urge the Senate to pass this legislation.

Good jobs depend on sound tax policy. Last year, some in this hall thought my tax relief plan was too small... and some thought it was too big. But when the checks arrived in the mail, most Americans thought tax relief was just about right. Congress listened to the people and responded by reducing tax rates, doubling the child credit, and ending the death tax. For the sake of long-term growth and to help Americans plan for the future, let’s make these tax cuts permanent.

The way out of this recession, the way to create jobs, is to grow the economy by encouraging investment in factories and equipment, and by speeding up tax relief so people have more money to spend. For the sake of American workers, let’s pass a stimulus package.

Good jobs must be the aim of welfare reform. As we re-authorize these important reforms, we must always remember the goal is to reduce dependency on government and offer every American the dignity of a job.

Americans know economic security can vanish in an instant without health security. I ask Congress to join me this year to enact a Patients’ Bill of Rights... to give uninsured workers credits to help buy health coverage... to approve an historic increase in the spending for veterans’ health... and to give seniors a sound and modern Medicare system that includes coverage for prescription drugs.

A good job should lead to security in retirement. I ask Congress to enact new safeguards for 401(k) and pension plans. Employees who have worked hard and saved all their lives should not have to risk losing everything if their company fails. Through stricter accounting standards and tougher disclosure requirements, corporate America must be made more accountable to employees and shareholders and held to the highest standards of conduct.

Retirement security also depends upon keeping the commitments of Social Security... and we will. We must make Social Security financially stable and allow personal retirement accounts for younger workers who choose them.

Members, you and I will work together in the months ahead on other issues: productive farm policy... a cleaner environment... broader home ownership, especially among minorities... and ways to encourage the good work of charities and faith-based groups. I ask you to join me on these important domestic issues in the same spirit of cooperation we have applied to our war against terrorism.

During these last few months, I have been humbled and privileged to see the true character of this country in a time of testing. Our enemies believed America was weak and materialistic, that we would splinter in fear and selfishness. They were as wrong as they are evil.

The American people have responded magnificently, with courage and compassion, strength and resolve. As I have met the heroes, hugged the families, and looked into the tired faces of rescuers, I have stood in awe of the American people.

And I hope you will join me in expressing thanks to one American for the strength, and calm, and comfort she brings to our Nation in crisis: our First Lady, Laura Bush.

None of us would ever wish the evil that was done on September 11th, yet after America was attacked, it was as if our entire country looked into a mirror, and saw our better selves. We were reminded that we are citizens, with obligations to each other, to our country, and to history. We began to think less of the goods we can accumulate, and more about the good we can do.

For too long our culture has said, “If it feels good, do it.” Now America is embracing a new ethic and a new creed: “Let’s roll.” In the sacrifice of soldiers, the fierce brotherhood of firefighters, and the bravery and generosity of ordinary citizens, we have glimpsed what a new culture of responsibility could look like. We want to be a Nation that serves goals larger than self. We have been offered a unique opportunity, and we must not let this moment pass.

My call tonight is for every American to commit at least two years... four thousand hours over the rest of your lifetime... to the service of your neighbors and your Nation.

Many are already serving and I thank you. If you aren’t sure how to help, I’ve got a good place to start. To sustain and extend the best that has emerged in America, I invite you to join the new USA Freedom Corps. The Freedom Corps will focus on three areas of need: responding in case of crisis at home, rebuilding our communities, and extending American compassion throughout the world.

One purpose of the USA Freedom Corps will be homeland security. America needs retired doctors and nurses who can be mobilized in major emergencies ... volunteers to help police and fire departments... transportation and utility workers well-trained in spotting danger.

Our country also needs citizens working to rebuild our communities. We need mentors to love children, especially children whose parents are in prison, and we need more talented teachers in troubled schools. USA Freedom Corps will expand and improve the good efforts of AmeriCorps and Senior Corps to recruit more than 200,000 new volunteers.

And America needs citizens to extend the compassion of our country to every part of the world. So we will renew the promise of the Peace Corps, double its volunteers over the next five years, and ask it to join a new effort to encourage development, and education, and opportunity in the Islamic world.

This time of adversity offers a unique moment of opportunity... a moment we must seize to change our culture. Through the gathering momentum of millions of acts of service and decency and kindness, I know: We can overcome evil with greater good.

And we have a great opportunity during this time of war to lead the world toward the values that will bring lasting peace. All fathers and mothers, in all societies, want their children to be educated and live free from poverty and violence. No people on earth yearn to be oppressed, or aspire to servitude, or eagerly await the midnight knock of the secret police.

If anyone doubts this, let them look to Afghanistan, where the Islamic “street” greeted the fall of tyranny with song and celebration. Let the skeptics look to Islam’s own rich history — with its centuries of learning, and tolerance, and progress.

America will lead by defending liberty and justice because they are right and true and unchanging for all people everywhere. No nation owns these aspirations, and no nation is exempt from them. We have no intention of imposing our culture — but America will always stand firm for the non-negotiable demands of human dignity: the rule of law... limits on the power of the state... respect for women... private property... free speech... equal justice... and religious tolerance.

America will take the side of brave men and women who advocate these values around the world — including the Islamic world — because we have a greater objective than eliminating threats and containing resentment. We seek a just and peaceful world beyond the war on terror.

In this moment of opportunity, a common danger is erasing old rivalries. America is working with Russia, China, and India in ways we never have before to achieve peace and prosperity. In every region, free markets and free trade and free societies are proving their power to lift lives. Together with friends and allies from Europe to Asia, and Africa to Latin America, we will demonstrate that the forces of terror cannot stop the momentum of freedom.

The last time I spoke here, I expressed the hope that life would return to normal. In some ways, it has. In others, it never will. Those of us who have lived through these challenging times have been changed by them. We’ve come to know truths that we will never question: Evil is real, and it must be opposed. Beyond all differences of race or creed, we are one country, mourning together and facing danger together. Deep in the American character, there is honor, and it is stronger than cynicism. And many have discovered again that even in tragedy... especially in tragedy... God is near.

In a single instant, we realized that this will be a decisive decade in the history of liberty — that we have been called to a unique role in human events. Rarely has the world faced a choice more clear or consequential.

Our enemies send other people’s children on missions of suicide and murder. They embrace tyranny and death as a cause and a creed. We stand for a different choice — made long ago, on the day of our founding. We affirm it again today. We choose freedom and the dignity of every life.

Steadfast in our purpose, we now press on. We have known freedom’s price. We have shown freedom’s power. And in this great conflict, my fellow Americans, we will see freedom’s victory.

Thank you all. May God bless.

January 15, 2002

Mr. Greenspan's economic comments on January 11th did little to clarify the economy's condition. [The Fed Chairman's full remarks are below.] We suggest that business conditions are worse than the Fed or the administration are willing to admit. However, if the Fed again cuts short-term rates at its late-January meeting one may assume that a business recovery is no where to be found on the economic horizon. Watch what they do - not what they say. Meanwhile, the Enron debacle has yet to filter through the financial system, where betting has largely replaced banking as the primary activity.

With job losses still rising, particularly in the manufacturing sector, consumers are unlikely to loosen their grip on their wallet in the near future. Ford Motor Company is the latest to announce that it is cutting 35,000 jobs worldwide and closing up to seven North American plants. With economic recovery a dim hope on a receding horizon, equity markets are now adjusting for the unwarranted run-up in stock prices since the tragedies of September 11th.

Manufacturing and business capital spending remains flat-to-contracting. Without a significant increase in business orders, we don't expect to see a worthwhile recovery. Corporate earnings projections for the next six months are unimpressive and do not reflect the hype coming from Wall Street-types. The Labor Department recently reported that the nation's unemployment rate climbed to 5.8% in December from a revised rate of 5.6% in November. December's 124,000 job losses are represented by declines in manufacturing, retail, air transportation and temp-employment services. On the positive side, the rate at which the economy lost jobs during December slowed from an average of 400,000 job losses in October and November. Further, retail sales dropped 0.1% in December.

January 11, 2002

Federal Reserve Chairman Alan Greenspan's comments to the Bay Area Council Conference in San Francisco on January 11, 2002.

“In the period immediately prior to September 11, there were tentative signs that some sectors of the U.S. economy had begun to stabilize, contributing to a hope that the worst of the previous cumulative weakness in world economic activity was nearing an end. That hope was decisively dashed by the tragic events of early September. Adding to the intense forces weighing on asset prices and economic activity before September 11 were new sources of uncertainty and risk that began to press down on global demand for goods and services.

In almost all areas of the world, economies weakened further, a cause for increasing uneasiness. The synchronous slowing in activity raised concerns that a self-reinforcing cycle of contraction, fed by perceptions of greater economic risk, could develop. Such an event, though rare, would not be unprecedented in business-cycle history.

We had already observed a coincident deceleration in activity among the world economies over the past year, owing apparently, at least in part, to the retrenchment in the high-technology sector. The global nature of most technology industries and the global reach of the capital markets in which the firms in these industries are valued and funded appears to have fostered a greater synchronousness in world activity in this cycle, seemingly broader than has generally been the case. However, before the terrorist attacks, it was far from obvious that this concurrent weakness was becoming self-reinforcing.

But, if ever a situation existed in which the fabric of business and consumer confidence, both here and abroad, was vulnerable to being breached, the shock of September 11 was surely it. Indeed, for a short period, in response to that shock, US economic activity did drop dramatically.

But, arguably, our economy has not been weakening cumulatively in recent weeks. In fact, indications of stabilization, similar in many respects to those observed in the period immediately preceding September 11, have been appearing with greater frequency. A possible significant contributor to this emergence of stability—if that is what it is—may be the very technologies that have fostered coincident global weakness: those that have substantially improved access of business decisionmakers to real-time information.

Thirty years ago, the timeliness of available information varied across companies and industries, often resulting in differences in the speed and magnitude of their responses to changing business conditions. In contrast to the situation that prevails today, businesses did not have real-time data systems that enabled decisionmakers in different enterprises to work from essentially the same set of information. In those earlier years, imbalances were inadvertently allowed to build to such an extent that their inevitable correction engendered significant economic stress. That process of correction and the accompanying economic and financial disruptions too often led to deep and prolonged recessions.

Today, businesses have large quantities of data available virtually in real time. As a consequence, they address and resolve economic imbalances more rapidly than in the past. At the same time, firms are largely operating with the same information set, and thus resolution of imbalances induces parallel movements in activity. Contractions initially may be steeper, but because imbalances are more readily contained, cyclical episodes overall should be less severe than would be the case otherwise.

In the current situation, inventories, especially among producers and purchasers of high-tech products, did run to excess over the past year, as sales forecasts went badly astray; alas, technology has not allowed us to see into the future any more clearly than we could previously. But, technology did facilitate the quick recognition of the weakening in sales and backup of inventories. This enabled producers to respond forcefully, as evidenced by output adjustments that have resulted in the extraordinary rate of inventory liquidation currently under way.

Inventories in many industries have been drawn down to levels at which firms will soon need to taper off their rate of liquidation, if they have not already done so. Indeed, in recent months, there have been fewer reports from industrial purchasing managers that their customers’ inventories are too high. Moreover, the relative stability of industrial commodity prices in recent weeks, and especially the recent firmness in the prices of semiconductors, could be hinting at less intense stock drawdowns.

A slowing in the rate of inventory liquidation will induce a rise in industrial production if demand for those products is stable or is falling only moderately. That rise in production will, other things being equal, increase household income and spending. The runoff of inventories, even apart from the large reduction in motor vehicle stocks, remained sizable in the fourth quarter. Hence, with production running well below sales, the potential positive effect of the inevitable cessation of inventory liquidation on income and spending could be significant.

But that impetus to activity will be short lived unless the demand for goods and services itself starts to rise. On that score, despite a number of encouraging signs of stabilization, it is still premature to conclude that the forces restraining economic activity here and abroad have abated enough to allow a steady recovery to take hold. For that to happen, sustained growth of final demand must kick in before the positive effects of the swing from inventory liquidation to accumulation dissipate.

For the household sector, which had been a major stabilizing force through most of last year’s slowdown, the outlook for demand is mixed. Low mortgage interest rates and favorable weather have provided considerable support to home-building in recent months. Moreover, attractive mortgage rates have bolstered both the sales of existing homes and the realized capital gains that those sales engender. They have also spurred refinancing of existing homes and the associated liquification of increases in house values. These gains have been important to the ongoing extraction of home equity for consumption and home modernization.

The recent rise in home mortgage rates, however, is likely to damp housing activity and equity extraction. It is already having an effect on cash-outs from refinancing. Cash-outs rose from an estimated annual rate of about $20 billion in early 2000 to a rate of roughly $75 billion in the third quarter of last year. But the pace of cash-outs has likely dropped noticeably in response to the recent decline in refinancing activity that has followed the backup in mortgage rates since early November.

Consumer spending received a considerable spur from the sales of new motor vehicles, which were remarkably strong in October and November owing to major financing incentives. Sales dropped last month when the incentives were scaled back, but have remained surprisingly resilient. Other consumer spending appears to have advanced in recent months, though at a subdued pace.

The substantial declines in the prices of natural gas, fuel oil, and gasoline have clearly provided some support to real disposable income and spending. These price declines added more than $50 billion at an annual rate to household purchasing power in the second half of last year. However, a decline in energy prices provides, in effect, only a one-shot boost to consumption, albeit one that is likely to take place over time. To have a more persistent effect on the ongoing growth of total personal consumption expenditures, energy prices would need to continue to decline. Futures prices do not suggest that such a decline is in the immediate offing, but the forecast record of these markets is less than sterling.

Although the quantitative magnitude and precise timing of the wealth effect remain uncertain, the steep decline in stock prices since March 2000 has, no doubt, curbed the growth of household spending. Although stock prices recently have retraced a portion of their earlier losses, the restraining effects from the net decline in equity values presumably have not, as yet, fully played out. Future wealth effects will depend importantly on whether corporate earnings improve to the extent currently embedded in share prices.

Perhaps most central to the outlook for consumer spending will be developments in the labor market. The pace of layoffs quickened last fall, especially after September 11, and the unemployment rate rose sharply. Over the past month or so, however, initial claims for unemployment insurance have declined markedly, on balance, suggesting some abatement in the rate of job loss.

Although this development would be welcome, the unemployment rate may well continue to rise for a time, and job losses can be expected to put something of a damper on consumer spending. However, the extent of that restraint will depend on how much of any rise in unemployment is the result of weakened demand and how much reflects strengthened productivity. In the latter case, average real incomes could rise, at least partially offsetting losses of purchasing power that stem from diminished levels of employment.

Finally, economic policies will have an important influence on household spending in the period ahead. No doubt, we will continue to benefit from the tendency of our tax and entitlement systems to buffer cyclical swings in income. Moreover, despite the failure of Congress to enact further tax cuts and spending increases, the continued phase-in of earlier reductions in taxes and the significant expansion of discretionary spending already enacted should provide noticeable short-term stimulus to demand.

Some of this stimulus has likely been offset by increases in long-term market interest rates, including those on home mortgages. The recent rise in these rates largely reflects the perception of improved prospects for the US economy. But over the past year, some of the firmness of long-term interest rates probably is the consequence of the fall of projected budget surpluses and the implied less-rapid paydowns of Treasury debt.

In our conduct of monetary policy, the Federal Reserve responded to the weakening economy over the past year by markedly lowering our target for the federal funds rate. We accelerated the pace of rate reductions during this period in response to the accelerated pace of economic adjustment. Moreover, the magnitude of policy adjustment and the resulting low level of the federal funds rate responded both to the strength of the forces restraining demand and to the continued subdued pace of underlying inflation. Liquidity, as a consequence, has expanded significantly, and the accompanying lower interest rates have supported spending and held down the cost to households of servicing debts.

The dynamics of inventory investment and the balance of factors influencing consumer demand will have important consequences for the economic outlook in coming months. But, the broad contours of the present cycle have been, and will continue to be, driven by the evolution of corporate profits and capital investment.

The retrenchment in capital spending over the past year was central to the sharp slowing we experienced in overall activity. The steep rise in high-tech spending that occurred in the early post-Y2K months was clearly not sustainable. The demand for many of the newer technologies was growing rapidly, but capacity was expanding even faster, exerting severe pressure on prices and profits. New orders for equipment and software hesitated in the middle of 2000, and then fell sharply as firms reevaluated their capital investment programs. Uncertainty about economic prospects boosted risk premiums significantly, and this rise, in turn, propelled required, or hurdle, rates of return to markedly elevated levels. In most cases, businesses required that new investments pay off much more rapidly than they had previously. For much of last year, the resulting decline in investment outlays was fierce and unrelenting. Although the weakness was most pronounced in the technology area, the reductions in capital outlays were broad-based.

These cutbacks in capital spending interacted with, and were reinforced by, falling profits and equity prices. Indeed, a striking feature of the current cyclical episode relative to many earlier ones has been the virtual absence of pricing power across much of American business, as increasing globalization and deregulation enhanced competition. In this low-inflation environment, firms have perceived very little capability to pass cost increases on to customers. Growth in hourly labor compensation has slowed in response to deteriorating economic conditions, but even those smaller increases have continued to outstrip gains in output per hour for the corporate sector on a consolidated basis. The result has been that profit margins are still under pressure.

Business managers, with little opportunity to raise prices, have moved aggressively to stabilize cash flows by trimming workforces. These efforts have limited the rise in unit costs, attenuated the pressure on profit margins, and ultimately helped to preserve the vast majority of private sector jobs. To the extent that businesses are successful in stabilizing and eventually boosting profits and cash flow, capital spending should begin to recover more noticeably.

Such success would likely be accompanied by a decline in elevated risk premiums back to more normal levels and, with real rates of return on high-tech equipment still attractive, should provide an additional spur to new investment. When capital spending eventually recovers, its growth is likely to be less frenetic than that which characterized 1999 and early 2000, when outlays were boosted by the dislocations of Y2K and the extraordinarily low cost of capital faced by many firms.

Still, the evidence strongly suggests that new technologies will present ample opportunities to earn enhanced rates of return. Indeed, anecdotal reports from businesses around the country suggest that the exploitation of available networking and other information technologies was only partially completed when the cyclical retrenchment of the past year began. Many business managers are still of the view, according to a recent survey of purchasing managers, that less than half of currently available new, and presumably profitable, supply chain technologies have been put into use.

While these opportunities remain abundant, they will now play out against the backdrop of a major uncertainty that we all must deal with these days—the specter of further terrorist incidents on American soil. It simply is not possible to predict whether there will be any such incidents or to forecast their possible consequences for the economy. But we can have little doubt that the tragic events of September 11 have left obvious marks on the economy that will not soon fade even though some of the initial impact of the shock has receded. Importantly, as I suggested shortly after the event, adjustments to new levels of perceived risk will cause a one-time downward shift in the level of productivity.

Clearly, businesses will be less comfortable now than they were before September 11 in allowing inventories to shrink to minimal levels in a just-in-time supply chain. Moreover, in some industries, resources will need to be diverted from efficiency-enhancing capital investment to providing security and contingency backup. Fragmentary data for the months following September 11, however, indicate output per hour is holding up well. Temporary labor-shedding may have overwhelmed the effects of added security and redundancy. It is not yet clear whether the negative shock to output per hour from the heightened risks is small, or just delayed. In any event, once these adjustments are completed, the full benefits of more rapid technological advance should show through to the growth of productivity.

The central role that is being played by technological advance poses special challenges to forecasters. Few technologies that influence our economic future are truly anticipated much in advance. And even when they are anticipated, their effect on economic growth is difficult to predict, in part because their pace of diffusion and application is so uncertain. The latter consideration is particularly significant to the longer-term rate of growth of productivity.

The events of the past decade clearly illustrate those difficulties. Few observers foresaw how microprocessors, integrated circuits, and the mating of laser technology with fiber optics, even well into their development and application, would rejuvenate the American economy.

For example, as recently as a decade ago, the outlook was for a continuation of meager gains in output per hour, with the rate of growth barely exceeding one percent per year, if that. Instead, during the last half of the 1990s, we experienced a surge in productivity growth well above the rate of increase experienced in the previous quarter-century.

Even as our economy slipped into recession, the growth of output per hour remained positive and, as I indicated earlier, has held up well even in the wake of September 11. Until last year, the hypothesis of an accelerated productivity trend had not been tested in the contracting phase of a business cycle. Recent developments have provided that test, and the early returns certainly look favorable to the hypothesis.

In retrospect, our economic structure changed in the mid-1990s. The crucial agent of this remarkable change was the quantum leap in information availability.

If the tentative indications that the contraction phase of this business cycle is drawing to a close are ultimately confirmed, we will have experienced a relatively mild downturn. To be sure, a great deal of real economic pain has been felt over the past year and a half. But imbalances have not been allowed to fester. They could have progressively undermined endeavors at stability and prolonged this difficult period.

The American economy has had to absorb some extraordinary shocks over the past year and a half. For the economy to have weathered as well as it has a severe deflation of equity asset values followed by an unprecedented blow from terrorists to the foundations of our market systems is impressive. In my judgment, this performance is a testament to the exceptional degree of resilience and flexibility that our economy has gained in recent years, much of which owes to advances not only in information technology, but to the globalization and deregulation of our markets, as well. The adaptability and resourcefulness of our businesses and workers have been especially important in this trying period.

There are sound reasons for concluding that the long-run picture remains bright, and even recent signals about the current course of the economy have turned from unremittingly negative through the late fall of last year to a far more mixed set of signals recently. But I would emphasize that we continue to face significant risks in the near term. Profits and investment remain weak and, as I noted, household spending is subject to restraint from the backup in interest rates, possible increases in unemployment, and from the effects of widespread equity asset price deflation over the past two years.

But if the recent more favorable developments continue and gather momentum, uncertainties will diminish, risk premiums will fall, and the pace of capital investment increase. Should those gains in investment materialize, they would, doubtless, embody the newest technologies. As we have witnessed so clearly in recent years, advances in technology have enhanced the growth of productivity, which, in turn, has been essential to lifting our standards of living.”