are likely to come onto the market in the months ahead due to the large volume of mortgage loans currently in the foreclosure process. for the government sector, large federal budget deficits are a constraint and fiscal policy is slowly shifting from an expansive policy back toward restraint. at the state and local level, the constraints are even more binding, as budgetary gaps will need to be addressed by spending cuts and tax increases ( chart 22 ). exports rebounded sharply over the second half of 2009, particularly to the emerging world ( chart 23 ). however, domestic demand in europe and japan – important export markets for the united states – remains very weak. this suggests that the u. s. trade balance is likely to change little over the next year or two, and, thus, will be relatively neutral in terms of its impact on growth. only business fixed investment is in a position to be a true locomotive of growth. profits have stayed high relative to investment, and corporate balance sheets are awash with cash ( charts 24 and 25 ). however, even here, the growth impulse is likely to be weak. prospective startup businesses are going to find it difficult to obtain funding. and larger businesses will unlikely increase investment spending sharply at a time when capacity utilization rates remain unusually depressed ( chart 26 ). relatively sluggish growth implies that the output gap will be closed very gradually. this suggests that inflation pressures will stay subdued. the excess supply of housing is putting downward pressure on rents, which represent a large share of the consumer price index ( cpi ) ( chart 27 ). in addition, unit labor costs have declined sharply over the past year due to the combination of unusually rapid productivity growth and slowing labor compensation growth ( chart 28 ). fortunately, longer term inflation expectations remain well anchored. these expectations have not declined and are broadly consistent with my views on the appropriate inflation goal ( chart 29 ). this is actually a welcome development right now because it will likely help to keep the trend inflation rate from falling too much. lessons to be learned we have just lived through a period in which rapid increases in asset prices led to a serious misallocation of resources and a severe financial crisis. what do we need to do to minimize the likelihood of avoiding this type of experience in the future? as i noted in a recent speech, we face three major challenges that will determine how smooth this economic expansion turns out to be. 5 first, we need regulatory reform that makes our financial system more stable and resilient

interventions by the federal reserve during the crisis were designed to safeguard the economy, for the benefit of all americans, while protecting the taxpayer. i am proud of our record on both accounts. in the end, the federal reserve ’ s extraordinary interventions achieved their intended purposes to support economic activity and, incidentally, taxpayers were compensated for the risks undertaken in these interventions. total profits from these interventions were more than $ 30 billion. 10 one important condition for lending in these programs was that the loan needed to be secured to the satisfaction of the federal reserve bank extending the loan. despite the degree of dislocation in the financial system at the time and the severity of the great recession, there were no losses for any of the fed ’ s programs. at the same time, i agree with those critics who argue that there was something fundamentally unfair about the disparity in treatment between the few large financial institutions that were saved versus the millions of individuals who lost their homes or their jobs. my response is not particularly satisfying. recessions inflict considerable pain on innocent bystanders in the economy. depressions greatly compound this pain. given the federal reserve ’ s role and authority, what we knew at the time and the powers and tools that were available to us, i think we made good choices. if the large systemic banking organizations had failed, the hardships inflicted on households and small business would have been far worse. 11 from my perspective, i believe that any critique of the fed or other agencies should be focused more on the regulatory and supervisory shortcomings – some of which, i admit, were ours – that created the economic and financial market circumstances in which the fed ’ s extraordinary interventions proved necessary. this leads me back to some of those lessons learned and the changes that have resulted. the crisis showed that the regulatory community did not fully grasp the vulnerability of the financial system. in particular, critical financial institutions were not resilient enough to cope with large scale disruptions without assistance, and problems in one institution quickly spread to others. in response, the federal reserve has made significant changes in how we regulate and supervise financial institutions. we have raised capital and liquidity requirements, put banks through annual stress tests, established the large institution supervision coordination committee ( liscc ) to enable us to evaluate the largest firms collectively and relative to one another, and set up the office of financial stability to enable the federal reserve was unable to prevent the bankruptcy of lehman brothers. for example, see “ federal reserve :