##defense capital goods have declined since autumn. moreover, weakness emerged more recently among our trading partners in europe, asia, and latin america. the interaction of slowdowns in a number of countries simultaneously has magnified the softening each of the individual economies would have experienced on its own. because the extent of the slowdown was not anticipated by businesses, some backup in inventories occurred, especially in the united states. innovations, such as more advanced supply - chain management and flexible manufacturing technologies, have enabled firms to adjust production levels more rapidly to changes in sales. but these improvements apparently have not solved the thornier problem of correctly anticipating demand. although inventory - sales ratios in most industries rose only moderately, those measures should be judged against businesses'desired levels. in this regard, extrapolation of the downtrend in inventory - sales ratios over the past decade suggests that considerable imbalances emerged late last year. confirming this impression, purchasing managers in the manufacturing sector reported in january that inventories in the hands of their customers had risen to excessively high levels. as a result, a round of inventory rebalancing was undertaken, and the slowdown in the economy that began in the middle of 2000 intensified. the adjustment process started late last year when manufacturers began to cut production to stem the accumulation of unwanted inventories. but inventories did not actually begin falling until early this year as producers decreased output levels considerably further. much of the inventory reduction in the first quarter reflected a dramatic scaling back of motor vehicle assemblies. however, inventories of computers, semiconductors, and communications products continued to build into the first quarter, and these stocks are only belatedly being brought under control. as best we can judge, some progress seems to have been made on inventories of semiconductors and computers, but little gain is apparent with respect to communications equipment. inventories of high - tech products overall have probably been reduced a bit, but a period of substantial liquidation of stocks still seemingly lies ahead for these products. for all inventories, the rate of liquidation appears to have been especially pronounced this winter, and the available data suggest that it continued, though perhaps at a more moderate pace, this spring. a not inconsequential proportion of the current liquidation undoubtedly is of imported products, and thus will presumably affect foreign production, but most of the adjustment has fallen on domestic producers. at some point, inventory liquidation will come to an end, and its termination will spur production and incomes

three - fourths of a percentage point through the first five months of this year, a not insignificant change, though half of that increase has been reversed since. by the nature of the indexed instrument, the spread between it and the comparable nominal rate reflects expected cpi inflation. while actual cpi inflation has picked up this year, this rise has not been mirrored uniformly in other broad price measures. for example, there has been little, if any, acceleration in the index of core personal consumption expenditure prices, which we consider to be a more reliable measure of inflation. moreover, survey readings on long term inflation expectations have remained quite stable. the lack of pricing power reported overwhelmingly by business people underscores the quiescence of inflationary pressures. businesses are experiencing the effects of softer demand in product markets overall, but these effects have been especially marked for many producers at earlier stages of processing, where prices generally have been flat to down thus far this year. with energy prices now also moving lower and the lessening of tautness in labor markets expected to damp wage increases, overall prices seem likely to be contained in the period ahead. forecasts of inflation, however, like all economic forecasts, do not have an enviable record. faced with such uncertainties, a central bank's vigilance against inflation is more than a monetary policy cliche ; it is, of course, the way we fulfill our ultimate mandate to promote maximum sustainable growth. a central bank can contain inflation over time under most conditions. but do we have the capability to eliminate booms and busts in economic activity? can fiscal and monetary policy acting at their optimum eliminate the business cycle, as some of the more optimistic followers of j. m. keynes seemed to believe several decades ago? the answer, in my judgment, is no, because there is no tool to change human nature. too often people are prone to recurring bouts of optimism and pessimism that manifest themselves from time to time in the buildup or cessation of speculative excesses. as i have noted in recent years, our only realistic response to a speculative bubble is to lean against the economic pressures that may accompany a rise in asset prices, bubble or not, and address forcefully the consequences of a sharp deflation of asset prices should they occur. while we are limited in our ability to anticipate and act on asset price bubbles, expectations about future economic developments nonetheless inevitably play a crucial role in our policymaking. if we react only to past