recent years. finally, the recent decline in energy prices, if it is sustained, should reduce cost pressures along the production chain. one upside risk to the inflation outlook comes from the labor market. the unemployment rate declined steadily between the second half of 2003 and the beginning of 2006 and has stood at a relatively low 4. 7 percent for the past six months. with labor markets comparatively tight by historical standards, unit labor costs have begun to accelerate, especially since the end of last year, and firms may pass on some of these higher costs to consumers. however, the large markup of prices over costs - the margin is currently well above its historical average - could act as a shock absorber if cost strains were to intensify. thus, in my judgment, inflation appears poised to decelerate in coming months as energy prices stabilize and resource pressures ease. but the risks to that outlook seem tilted toward the upside. aggregate supply in considering the appropriate setting for monetary policy, the level of the economy ’ s underlying productive capacity - its potential output - is the benchmark against which we assess actual output. accordingly, whether the recent slowdown in economic activity eases resource constraints enough to reduce inflationary pressure depends importantly on how fast potential output is growing. if the key determinants of potential output - the workforce, economic efficiency, and the capital stock - grow quickly, as they did in the second half of the 1990s, then gdp can also rise quickly without increasing the pressure on the economy ’ s resources. conversely, a reduced rate of growth of potential output would require slower growth of actual gdp to keep resource pressures from increasing. i ’ d like to spend a little time examining in greater depth the outlook for some of the factors that determine potential output, starting with the labor force. the size of the labor force depends on a combination of two factors : the size of the working - age population and the likelihood that members of this population join the labor force - a likelihood that economists refer to as the labor force participation rate. the labor force participation rate tends to vary over the business cycle as potential workers become more or less encouraged about job prospects. however, the influence of labor force participation on potential output does not depend on short - run conditions in the labor market but rather on long - run changes due to demographic and social factors. for instance, in the 1950s and 1960s the labor force participation rate stood at just under 60 percent. in subsequent years, women entered the labor force in large numbers and

years, these prices have begun rising again in the past year at a time when inflation remains relatively low. so if import prices, resource utilization, and transitory factors together do not provide a complete account, why has inflation been so much lower in the past few years than it was previously? in many of the models economists use to analyze inflation, a key feature is “ underlying, ” or trend, inflation, which is believed to anchor the rate of inflation over a fairly long horizon. underlying 2 / 7 bis central bankers'speeches inflation can be thought of as the slow - moving trend that exerts a strong pull on wage and price setting and is often viewed as related to some notion of longer - run inflation expectations. there is no single highly reliable measure of that underlying trend or the closely associated notion of longer - run inflation expectations. nonetheless, a variety of measures suggest underlying trend inflation may currently be lower than it was before the crisis, contributing to the ongoing shortfall of inflation from our objective. that conclusion is suggested by estimates based on time - series models, longer - run expectations from the university of michigan surveys of consumers and survey of professional forecasters, and market - based measures of inflation compensation. starting with time - series models, one model that has been used by a variety of researchers suggests that underlying trend inflation may have moved down by perhaps as much as 1 / 2 percentage point over the past decade. 4 market - based measures of inflation compensation provide another read on inflation expectations. comparing the three - year period ending in the second quarter of this year with the three - year period ended just before the financial crisis, 10year - ahead inflation compensation based on tips ( treasury inflation - protected securities ) yields is 3 / 4 percentage point lower. 5 survey - based measures of inflation expectations are also lower. the michigan survey measure of median household expectations of inflation over the next five to 10 years suggests a 1 / 4 percentage point downward shift over the most recent three - year period compared with the pre - crisis years, similar to the five - year, five - year forward forecast for the consumer price index from the survey of professional forecasters. why might underlying inflation expectations have moved down since the financial crisis? one simple explanation may be the experience of persistently low inflation : households and firms have experienced a prolonged period of inflation below our objective, and that may be affecting their perception of underlying inflation. a related explanation may be the greater proximity of the federal funds rate to its effective lower bound due