guide to the likely economic effects of the hurricanes, but the unique characteristics of these two storms - - including the devastation of a major city and the displacement of its population - - clearly put us in uncharted territory. nonetheless, i think it is useful to think about a natural disaster as having three relatively distinct phases. in the first phase, production and sales decline in the affected area. in the second phase, activity bounces back as initial repairs are made to damaged infrastructure and the disruptions recede. in the third phase, rebuilding activity boosts production for a time, and real gdp can actually be higher than it would have been in the absence of the disaster. in the long run, once national saving has increased enough to restore the national net worth to its desired level, the effect of the disaster on economic activity essentially disappears. obviously, the recoveries of the various communities and industries affected by the hurricanes will have different time profiles. for example, the need to drain new orleans of water and clear it of any environmental hazards will slow the pace of its recovery relative to other areas that did not suffer from extreme flooding. but, i think that the bulk of the disruptions from the storms will be felt in the second half of this year. a significant portion of this effect results from the reduced output of oil, natural gas, and refined petroleum products. although the additional losses of energy production in the wake of hurricane rita are clearly a negative for growth, repair and recovery activities should pick up as we 2 / 5 move through the fourth quarter. there are, of course, substantial uncertainties both about the actual dimension of the economic effects and about the abilities of our statistical systems to measure these effects. but the effects on the growth of real gdp in the second half of the year should be noticeable. in 2006, the recovery process is expected to contribute to the growth of real gdp. i should note that a key element in this recovery is the federal aid package, which provides some income support to evacuees and, in effect, finances a sizable portion of the reconstruction activity. without this federal effort, the dislocations from the hurricanes likely would have a much greater negative effect on aggregate demand, and the rebuilding process would occur more slowly. at this point, it seems likely that the hurricanes had, at most, a small effect on the supply side of the economy. the losses of productive capital, while devastating in the regions directly affected, appear to be small relative to the overall

a necessary first step to updating the economic outlook after the storms. finally, i would like to talk about the macroeconomic consequences of sharply higher energy prices that, if futures markets are an accurate guide, appear likely to persist long after rebuilding has been completed. the economy before the hurricanes before the hurricanes, economic activity appeared to have had considerable near - term momentum. payroll employment continued to increase through august, and other indicators suggested that further gains in production and sales were in train during july and august. consumer spending was growing briskly despite rapidly rising energy prices. sales of light motor vehicles were especially robust - - the result of the " employee pricing " plans offered by the major automakers. new residential construction remained at or near historically high levels through the summer, as did home sales. in contrast, business investment appeared to have lost a bit of steam. on net, real gross domestic product ( gdp ) looked likely to accelerate somewhat in the third and fourth quarters from the 3 - 1 / 2 percent annual rate registered in the first half of the year. on the price side of the ledger, consumer price inflation was moving up in response to the direct effects of higher energy prices. crude oil prices continued to rise before the storms hit as the growth in world demand for refined petroleum products further outstripped the growth of world supply. meanwhile, the readings on core consumer price inflation - - that is consumer price inflation excluding the direct effects of energy and food prices - - had been favorable, coming in well below the more - elevated pace seen earlier in 2005. of course, some of this slowdown in core price inflation was attributable to the temporary effects of the employee - pricing programs for light vehicles. and 1 / 5 higher energy costs were expected to place continued upward pressure on the prices of other goods and services. in this environment of somewhat faster growth in aggregate spending and greater upward pressure on prices, the federal open market committee ( fomc ) raised its target for the federal funds rate to 3 - 1 / 2 percent in early august. at the same time, the committee reiterated its belief that, with the appropriate monetary policy actions, the upside and downside risks to the outlook for sustainable economic growth and price stability were roughly equal and that the removal of monetary accommodation could proceed at a " measured pace. " thus, before the hurricanes, the outlook was relatively benign : continued moderate economic growth accompanied by little change in the underlying pace of core inflation. there were, of course, risks