susan schmidt bies : comments on the current state of the economy remarks by ms susan schmidt bies, member of the board of governors of the us federal reserve system, at the annual economic outlook conference, middle tennessee state university, murfreesboro, tennessee, 8 october 2003. * * * it is a pleasure to be with you this morning at the annual economic outlook conference of middle tennessee state university to discuss the state of the economy. as you will hear, recent readings on the economy suggest that the pace of economic activity has picked up of late, our financial system is healthy, and inflation pressures remain subdued. although uncertainties remain, i believe that the economic fundamentals are now in place to generate a sustainable, non - inflationary upturn. as always, the views that i will express are my own and do not necessarily reflect those of the board of governors or the staff of the federal reserve system. i am going to describe the key factors that have dominated this recession and recovery. then i will talk about the current state of the household and business sectors. finally, i want to make some remarks about corporate - sponsored, defined - benefit pension plans. the recent economic cycle before delving into current events, i think it is helpful to review some of the key aspects of our recent economic history. after a record, ten - year economic expansion, the u. s. economy slipped into recession in march 2001. this recession was unusual in that it was led by a drop in business investment, rather than a decline in consumer spending. according to the national bureau of economic research ( the traditional record keeper of u. s. business cycles ) the downturn lasted eight months - a bit less than the duration of the average post - war recession. but thereafter, between the trough of the recession in 2001 and the second quarter of this year, real gross domestic product grew at a rather disappointing annual rate of 2 - 3 / 4 percent, on average. although household disposable income and spending increased appreciably over this period, capital spending continued to weaken. indeed, in the second quarter of this year, real business fixed investment was 4 percent below its level at the trough of the recession - an unusually weak investment performance almost two years into a recovery. financial conditions undoubtedly played an important role in these developments. in the late 1990s, financial conditions were easy. very narrow risk premiums in both debt and equity markets and lofty expectations about returns on the part of investors and

little difficulty raising funds to replenish their pensions. this suggests that pension contributions will not likely be a major cash flow impediment to corporate investment. that is not to say, however, that many firms - indeed, whole industries - are not struggling with their pension plans. severe cases can be found in the auto, steel, and airline industries, where long - term business structure issues make the recent business - cycle effects on pension plans more acute. these firms face a confluence of negative trends, including increasing competitive pressures, aging workforces, rapidly growing retiree populations, and a history of collective bargaining agreements that emphasized larger pension benefits over wage increases. automakers currently face some of the largest dollar amounts of underfunding, but as noted earlier, they generally have good access to credit markets, which has allowed them to weather these difficulties. steel companies and airlines have had a harder time. in the past two years, a half - dozen large, established steel firms and airlines have declared bankruptcy, and their pension plans either have collapsed or remain mired in uncertainty. not surprisingly, required pension contributions represent a greater burden on cash flow to the surviving firms in these troubled industries. although most db pension contributions are made in cash, some airlines and steel companies have turned to making noncash contributions - company stock, generally - to their pension plans. while this conserves cash for other uses, it increases the risk in plan funding since the value of plan assets will be more correlated with the health of the sponsor. thus when the company gets into financial difficulties, the ability to contribute to the pension plan will be the weakest just when the declining value of those plan assets requires larger contributions. the recent experiences of the steel and airline industries, in particular, have led to the sudden reversal of fortune for the pension benefit guaranty corporation, or pbgc - the federally chartered company that partially insures pension benefits by assuming the assets and some of the liabilities of failed plans. each time the pbgc takes over a bankrupt firm ’ s plan, it assumes a new claim that comes due as the firm ’ s workers retire. new claims have skyrocketed in the past few years - from an average of $ 150 million per year in the late 1990s to $ 3. 3 billion in 2002. this year will be worse. thanks to several large new bankruptcies, claims exceeded $ 5 billion in just the first half of fiscal year 2003. these plan failures have had an enormous