confidence is another channel through which a correction in house prices could affect the economy. in the current situation, a sizable deceleration in house prices could have an outsized effect on consumer confidence and thereby reduce household spending by more than is implied by conventional estimates of the wealth effect. another possible avenue for gauging the effects of housing prices on the economy is to look at experiences in other countries. house prices have risen markedly in recent years in many industrial countries amid low long - term interest rates, ample liquidity, and steady economic growth. although movements in real house prices flattened out or turned down in several countries in the first half of 2005, they have since recovered for the most part. of the countries that have seen recent booms in house prices, australia has experienced a decline in real house prices over the past year ; real prices are down about 3 percent since their peak at the end of 2003. during this period, residential investment contracted, and the growth of real consumption slowed a bit ; but the economy continued to grow, in part because investment in other sectors picked up in response to strong global demand. more countries have experienced a slowdown in rates of increase in home prices than experienced an outright decline. for example, in the netherlands - - where residential property prices rose particularly rapidly in the late 1990s - - the rate of increase slowed significantly beginning in 2000. in 2002 and 2003, the economy experienced a mild recession, with domestic demand contracting as a result of declines in investment ( including residential investment ) and contracting consumption. but, even so, the economy started to recover in 2004 and 2005, and house prices there have continued to rise in recent years. in the united kingdom, house prices also flattened out last year, and this deceleration was accompanied by a slowdown in real consumption growth. more recently, house prices have started rising again, and consumption growth has also picked up. the experiences in australia and the united kingdom could be taken as suggesting that adjustments in house prices can be associated, on balance, with continued modest economic growth, while the dutch experience paints a slightly more pessimistic picture. having said that, one difficulty in interpreting the foreign evidence is that gauging the direction of causality is difficult - - that is, are adjustments in house prices causing a slowdown in real economic growth or is a slowdown in activity causing the adjustment in house prices. on this point, a recent federal reserve study of international experience documented the pro - cyclicality of real

##ress the banking system and repair the finances of the corporate sector. as investor confidence has returned, exchange rates have risen and interest rates have fallen. with persistence and follow - through on reforms, the future of those economies has promise. the situations in some other emerging market economies are not as encouraging. the russian government ’ s decision in mid - august to suspend payments on its domestic debt and devalue the ruble took markets by surprise. investor flight exacerbated the collapse of prices in russian financial markets and led to a sharp depreciation of the ruble. the earlier decline in output gathered momentum, and by late in the year inflation had moved up to a triple - digit annual rate. russia ’ s stabilization program with the imf has been on hold since the financial crisis hit, and the economic outlook there remains troubling. the russian financial crisis immediately spilled over to some other countries, hitting latin america especially hard. countering downward pressure on the exchange values of the affected currencies, interest rates moved sharply higher, especially in brazil. as a consequence of the high interest rates and growing economic uncertainty, brazil ’ s economic activity took a turn for the worse. higher interest rates also had negative consequences for the fiscal outlook, as much of brazil ’ s substantial domestic debt effectively carries floating interest rates. with budget reform legislation encountering various setbacks, market confidence waned further and capital outflows from brazil continued, drawing down foreign currency reserves. ultimately, the decision was taken to allow the real to float, and it subsequently depreciated sharply. brazilian authorities must walk a very narrow, difficult path of restoring confidence and keeping inflation contained with monetary policy while dealing with serious fiscal imbalances. although the situation in brazil remains uncertain, there has been limited contagion to other countries thus far. apparently, the slow onset of the crisis has enabled many parties with brazilian exposures to hedge those positions or allow them to run off. with the net exposure smaller, and increasingly held by those who both recognized the heightened risk and were willing to bear it, some of the elements that might have contributed to further contagion may have been significantly reduced. the economic outlook these recent domestic and international developments provide the backdrop for u. s. economic prospects. our economy ’ s performance should remain solid this year, though likely with a slower pace of economic expansion and a slightly higher rate of overall inflation than last year. the stocks of business equipment, housing, and household durable