extraordinary 8 plus - percent rate in the third quarter. in part, these gains are cyclical and reflect firms ’ unwillingness, until recently, to expand their payrolls. in addition, the productivity gains have translated into an improvement in businesses ’ income statements : real wages have not kept up with the growth in productivity, and with businesses generally reluctant to spend, corporate profitability has improved markedly this year. this development has allowed firms to reduce the debts inherited from the 1990s. some slowing in productivity growth from the third - quarter pace is almost inevitable. however, looking beyond the quarter - to - quarter movements, i remain optimistic that we have seen a permanent step - up in the underlying rate of labor productivity growth. as i noted before, businesses have achieved considerable efficiency gains through the information technology that they have installed since 1995. moreover, as my y2k example illustrated, i believe companies are continuing to adapt their operations to take advantage of the capabilities of these technologies and are seeing a payoff for these actions in their bottom lines. the apparent step - up in the underlying rate of productivity growth in recent years implies that the nation ’ s rate of potential output growth - the rate of growth in real gdp that is consistent over time with a stable rate of inflation - has also risen. that ’ s good news because it means that the economy can grow at a faster pace than in the past without generating upward pressure on prices. moreover, the level of potential output is still well above that of actual gdp, and this output gap is likely to persist for some time even if real gdp grows in excess of its potential pace. finally, let me say a few words about inflation. although the overall consumer price index has been buffeted by swings in food and energy prices, the core measure that excludes these components has slowed noticeably over the past year. the core cpi is up only 1¼ percent from its level of a year ago. this performance means that the u. s. economy has reached effective price stability. that is an achievement that owes to many factors : economic slack, faster productivity growth, stable inflation expectations, and the general public ’ s belief that the federal reserve is committed to keeping inflation under control. moreover, recent research has shown that, as inflation has been brought down over the past two decades, the sensitivity of prices to the level of resource utilization has also fallen. this finding implies that, unlike in past periods, the specter of rising inflation is less likely to haunt the economy as

jumped to an annual rate of 1. 62 million units in october, a record high for this series. moreover, sales of both new and existing homes have also held near historical highs. as i noted before, the business sector has been the locus of weakness in this expansion. however, the extreme caution that had been gripping firms now appears to be dissipating. real outlays for equipment and software rose at an annual rate of 15½ percent in the third quarter, after an increase of 8¼ percent in the second quarter. moreover, businesses also are hiring again. private non - farm payrolls increased at an average pace of about 120, 000 per month in september and october, and further declines in initial claims for unemployment insurance suggest that this improvement in the labor market has continued into november. finally, manufacturing production is perking up. although light vehicle assemblies have slipped from the very high levels of the summer, production of other goods rose 0. 2 percent in september and an additional 0. 4 percent in october, reflecting fairly widespread gains across industries. the sustainability of the recovery will depend importantly on future trends in employment, household spending, and business investment. twice before in this recovery we have seen short periods of strong growth, followed by a return to sluggish, subpar growth. given the strength of the incoming data that i have just outlined, the risk that the economy will again stall out must be given a smaller probability than that assigned just a few months ago, but the risk cannot be discounted completely. for example, the strength in consumer spending in the third quarter might prove to be temporary - a one - time surge related to the fiscal stimulus. indeed, analysts who subscribe to this view would take some solace in the latest data on non - auto retail sales. under these circumstances, businesses likely would remain very cautious about the demand conditions they expect to prevail in the year ahead. this would make them reluctant to expand and hire new workers - factors that would hold down economic expansion in 2004. while the consensus forecast for next year calls for a growth rate of 4 percent ( on a fourth - quarter - to - fourth - quarter basis ), which seems reasonable, a weaker outcome than that is not hard to imagine. productivity, potential growth and inflation one of the most prominent characteristics of this economic expansion has been the rapid gains in labor productivity. output per hour rose at an annual rate of 4½ percent in the first half of this year and at an