##hang of owner - occupied units ; hence, i do not expect rents to be a major influence on core inflation a year or two from now, the horizon that is the focus of monetary policymaking. clearly, however, the band of uncertainty about such a forecast is rather wide. not only should the contribution of energy and shelter costs to underlying inflation be diminishing over coming quarters, but the generalized pressure of demand on supply should also decrease if, as i am anticipating, economic growth falls short of potential for a time. i would not expect modest changes in the output gap to exert more than a marginal influence on inflation. but the anticipated slower pace of growth will result in an environment in which firms will be less able to pass on increases in costs. one potential source of higher costs comes from the labor market. i would not be surprised to see a gradual rise in labor costs as workers capture a greater share of the productivity gains of recent years. however, compensation per hour, a measure derived from unemployment insurance tax records, indicates that labor costs accelerated sharply, to a pace of 7 - 3 / 4 percent from the second quarter of 2005 to the second quarter of 2006. in contrast, readings from the employer cost index ( eci ), which is derived from a probability sample of firms, shows labor costs decelerating. some of the divergence appears to be the result of an increased volume of stock option exercises in early 2006 - an occurrence captured by the compensation per hour measure but not by the eci - and these option exercises should not represent costs that firms actually internalize when calculating their marginal cost of production. thus, in my own thinking, i have tended to discount, though not dismiss, the latest readings on labor costs. however, i acknowledge that rising labor costs are an upside risk to my inflation outlook, especially if they occur under product - market conditions in which firms can readily pass costs through. in sum, i think that the odds favor a gradual reduction in core inflation over the next year or so, but the risks around this outlook do not seem symmetric to me : important upside risks to the outlook for inflation warrant continued vigilance on the part of the central bank. i say that not only because of the questions about underlying labor costs and about the future direction of energy and shelter prices but also because our understanding of the inflation process is limited, and i cannot rule out the possibility that the upward movement earlier this year reflected a more persistent impulse that i cannot now identify

protecting consumers while ensuring that creditors continue to provide credit responsibly. an important part of my research as an economics professor at the university of chicago, and my practical policy work as a member of the council of economic advisers, was devoted to banking and financial regulation as well as banking and financial crises. the safety and soundness of the u. s. banking and payments systems is critical to achieving economic growth, maximum employment, and general economic stability, and the federal reserve works closely with other regulators to achieve this goal. the federal reserve also has an important role to play in responding to and mitigating the impact of financial crises and shocks. if confirmed, i would continue to work vigorously to protect and promote the safety and soundness of the system. thank you once again for holding this hearing, and i look forward to your questions.