year. but that is by no means a certainty. one particular risk is that the problems that have thus far been most severe in asia may become more severe in other regions of the world. we have already seen this in russia, and financial difficulties in other countries as distinct as south africa and brazil emphasize the worries and uncertainties on this score. for a variety of reasons, there could be a more “ contagion ” to other countries. first, investors ’ appetite for international risks has gone down following the asian crises. this has led to trouble for countries that are running current account deficits and so are dependent on foreign capital. while most of russia ’ s problems are home grown, for example, more cautious investors probably contributed to precipitating that country ’ s crisis. indeed, over the last month it has become apparent that even us financial markets are not immune to perceptions that risk has increased. second, as some emerging - market countries with fixed exchange rates respond to market pressures by relaxing their exchange - rate arrangements, those remaining countries attempting to peg their exchange rates may come under increasing speculative pressures. third, countries that have close economic ties to the hardest - hit asian nations certainly are feeling the repercussions of a reduction in demand for their exports, and a greater economic slowdown in asia could trigger financial problems in those countries, too. and finally, as i noted earlier, countries that are heavy exporters of oil and other primary commodities have been hard - hit by low prices. in short, international problems in asia and elsewhere are proving to be more profound and sustained than many, myself included, were guessing and hoping would be the case. obviously, the effect of this drag on our ongoing economic expansion is an area that deserves close scrutiny in the months ahead. inflation developments but as i noted, the flip side of reduced export demand and a strong dollar is that the international situation is helping to hold down inflation here at home. this helps to explain the remarkable fact that our strong economic growth and low unemployment rates have coincided with exceptionally favorable news on the inflation front. i cannot overemphasize the importance of this story : rising inflation has sown the seeds of almost every cyclical downturn of the last half century. the consumer price index increased less than 2 percent over the past year. the last time consumer inflation was this low was in 1986 when, as in the present instance, consumers benefited from declining prices of energy products. but even when we exclude volatile food and

the fact that the nominal federal funds rate remains quite low does not, by itself and without context, signal that policy is loose. after all, spending decisions should depend on real, not nominal, determinants, including the real federal funds rate, which is the nominal federal funds rate less prevailing inflation expectations. although backward - looking measures of inflation - such as the four - quarter growth in core personal consumption expenditure ( pce ) prices - imply that the fomc ’ s cumulative 75 basis points of tightening so far this year has moved the real federal funds rate into positive territory for the first time in almost three years, that observation is not sufficient to calibrate the stance of policy. for example, the u. s. economy expanded at about the same average pace from 1981 to 1990 and from 1991 to 2000. in the earlier period, however, the real short - term rate averaged 4 - 3 / 4 percent whereas in the more recent one the real rate was 2 percentage points lower. clearly, prevailing conditions matter in determining the degree of policy accommodation. it is only against a backdrop of an economy that seems poised to maintain sustained and solid economic growth, even as the funds rate rises, that the fomc can determine that current policy is accommodative. the equilibrium rate in theory what is needed is a benchmark summarizing the economic circumstances - including, among other variables, the underlying strength of aggregate demand, the level of aggregate wealth, and economic developments in our trading partners - combining to shape the expansion of activity and the extent of pressures on inflation. one way of providing that benchmark is to consider what level of the real federal funds rate, if allowed to prevail for several years, would place economic activity at its potential and keep inflation low and stable. if the actual real rate is below that benchmark level, policy can be viewed as accommodative, in that if that stance were maintained, ultimately pressures on resources would build. if the actual real rate is kept above that benchmark level, policy would seem to be contractionary. this definition makes clear that the most relevant aid in policymaking is an intermediate - run measure, in that there may be forces at work in the shorter run that push spending away from potential output even if the real rate were pegged at this benchmark rate. it also makes clear that the concept involves a good amount of judgment - indeed, the same judgment that goes into making any economic forecast - about