of tenants, consumer installment credit, and auto leases, the total servicing costs faced by households relative to their incomes are below previous peaks and do not appear to be a significant cause for concern at this time. while household spending has been reasonably vigorous, we have yet to see convincing signs of a rebound in business outlays. after having fallen sharply over the preceding two years, new orders for capital equipment stabilized and, for some categories, turned up in nominal terms in 2002. investment in equipment and software is estimated to have risen at a 5 % rate in real terms in the fourth quarter and a subpar 3 % over the four quarters of the year. however, the emergence of a sustained and broad - based pickup in capital spending will almost surely require the resumption of substantial gains in corporate profits. profit margins apparently did improve a bit last year, aided importantly by the strong growth in labor productivity. of course, the path of capital investment will depend not only on market conditions and the prospects for profits and cash flow but also on the resolution of the uncertainties surrounding the business outlook. indeed, the heightening of geopolitical tensions has only added to the marked uncertainties that have piled up over the past three years, creating formidable barriers to new investment and thus to a resumption of vigorous expansion of overall economic activity. the intensification of geopolitical risks makes discerning the economic path ahead especially difficult. if these uncertainties diminish considerably in the near term, we should be able to tell far better whether we are dealing with a business sector and an economy poised to grow more rapidly - our more probable expectation - or one that is still laboring under persisting strains and imbalances that have been misidentified as transitory. certainly, financial conditions would not seem to impose a significant hurdle to a turnaround in business spending. yields on risk - free treasury securities have fallen, risk spreads are narrower on corporate bonds, premiums on credit default swaps have retraced most of their summer spike, and liquidity conditions have improved in capital markets. these factors, if maintained, should eventually facilitate more vigorous corporate outlays. if instead, contrary to our expectations, we find that, despite the removal of the iraq - related uncertainties, constraints to expansion remain, various initiatives for conventional monetary and fiscal stimulus will doubtless move higher on the policy agenda. but as part of that process, the experience of recent years may be instructive

but only modestly. as previously, overall growth has simultaneously been supported by relatively strong spending by households and weighed down by weak expenditures by businesses. importantly, the favorable underlying trends in productivity have continued ; despite little change last quarter, output per hour in the nonfarm business sector rose 3¾ % over the four quarters of 2002, an impressive gain for a period of generally lackluster economic performance. one consequence of the combination of sluggish output growth and rapid productivity gains has been that the labor market has remained quite soft. employment turned down in the final months of last year, and the unemployment rate moved up, but the report for january was somewhat more encouraging. another consequence of the strong performance of productivity has been its support of household incomes despite the softness of labor markets. those gains in income, combined with very low interest rates and reduced taxes, have permitted relatively robust advances in residential construction and household expenditures. indeed, residential construction activity moved up steadily over the year. and despite large swings in sales, underlying demand for motor vehicles appears to have been well maintained. other consumer outlays, financed partly by the large extraction of built - up equity in homes, have continued to trend up. most equity extraction - reflecting the realized capital gains on home sales - usually occurs as a consequence of house turnover. but during the past year, an almost equal amount reflected the debt - financed cash - outs associated with an unprecedented surge in mortgage refinancings. such refinancing activity is bound to contract at some point, as average interest rates on outstanding home mortgages converge to interest rates on new mortgages. however, fixed mortgage rates remain extraordinarily low, and applications for refinancing are not far off their peaks. simply processing the backlog of earlier applications will take some time, and this factor alone suggests that refinancing originations and cash - outs will be significant at least through the early part of this year. to be sure, the mortgage debt of homeowners relative to their income is high by historical norms. but as a consequence of low interest rates, the servicing requirement for the mortgage debt of homeowners relative to the corresponding disposable income of that group is well below the high levels of the early 1990s. moreover, owing to continued large gains in residential real estate values, equity in homes has continued to rise despite sizable debt - financed extractions. adding in the fixed costs associated with other financial obligations, such as rental payments