susan schmidt bies : the economic outlook and financial health of bank customers remarks by ms susan schmidt bies, member of the board of governors of the us federal reserve system, at the economic growth and regulatory paperwork reduction act banker outreach meeting, nashville, tennessee, 22 april 2004. * * * i am delighted to be back in tennessee today and to have a chance to visit with some old friends. i also want to thank you for giving so much of your time to help us identify ways to reduce unnecessary and unduly burdensome regulatory requirements on financial institutions. there is a real need to continually review the cost - benefit nexus of regulations, especially with the fast pace of evolution in financial markets and institutions. thus, my colleagues in the federal reserve system and i are strong supporters of the goals of today's meeting. it is a critical supplement to our own efforts, which include a review of our regulations every five years to revise or rescind out - of - date or unnecessary rules. i thought that after lunch you might find it interesting to shift to a discussion of the financial health of bank customers and the economy. in that spirit, i would like to briefly share with you my assessment of the economic outlook and then to discuss in more detail how the evolution of household and business balance sheets in recent years is affecting economic activity. you should understand, however, that i am expressing my own opinions, which are not necessarily those of my colleagues on the board or on the federal open market committee. the economic outlook as you know, real gdp grew at an annual rate of 6. 2 percent in the second half of 2003, and the economic fundamentals seem to be in place for another sizable advance this year. indeed, the central tendency range of fomc - member forecasts is 4 - 1 / 2 to 5 percent. yet despite the recent strong pace of economic activity, the labor market has improved at an unusually slow pace by historical standards. the most recent data - indicating a jump in payrolls in march - was good news, and i am cautiously optimistic that job growth will pick up further over the remainder of this year. my business contacts tell me that companies have become more optimistic about economic prospects and that their plans do include increases in the size of their payrolls. the latest data on consumer prices suggest that the process of disinflation may have come to an end. in march 2004, the twelve - month change in the core cpi rose to 1. 6 percent

many firms have refinanced high - cost debt, which has reduced the average interest rate on the debt of nonfinancial corporations more than 1 percentage point since the end of 2000. businesses also have substituted long - term debt for short - maturity debt to improve their balance sheet liquidity and to reduce the risk of rolling over funds. in addition, many firms - especially in the most troubled industries - have retired debt through equity offerings and asset sales, which limited the growth of nonfinancial corporate debt in 2002 and 2003 to the slowest pace since the early 1990s. third, firms have significantly tightened their belts. over the past two years, the drive to cut costs has generated rapid productivity gains. this greater efficiency boosted corporate profitability in 2002 and 2003 despite rather tepid revenue growth. moreover, a pickup in revenue growth in the second half of last year helped companies leverage those productivity gains, producing a dramatic recovery in overall corporate profitability. over 2003, economic profits before tax surged more than 18 percent, bringing profit margins to their highest levels in several years. fourth, risk premiums fell substantially last year as corporate governance scandals receded and investor sentiment turned markedly more positive. the recovery in stock prices reflects this brighter view. spreads on corporate bonds have narrowed appreciably - especially for the riskiest firms - and they now stand at the lowest levels in several years. this decline in spreads has been helped by the beneficial effect of the balance sheet improvements that i mentioned a moment ago. indicators of corporate financial stress, such as bond rating downgrades and default rates, have returned to levels normally associated with economic expansion. delinquency rates on business loans at commercial banks have also declined, and our surveys indicate that, on balance, banks have recently eased the terms and standards on such loans for both large and small firms. another sign of improved sentiment is that money has been flowing into riskier securities. for example, net inflows to equity mutual funds have been strong for about a year, and high - yield bond funds, too, registered strong net inflows in 2003. junk bond issuance has picked up notably, and the market for initial public equity offerings has also shown signs of recovery, while investors still appear to be more selective than during the boom in the late 1990s. these four points all suggest that financial conditions are capable of supporting a sustained, healthy pickup in economic growth. the much improved profitability can help finance expansion directly out of internal funds