prices following enron ’ s collapse has chastened many of the uncritical practitioners of questionable accounting. corporate reputation is fortunately reemerging out of the ashes of the enron debacle as a significant economic value. markets are evidently beginning to put a price - earnings premium on reported earnings that appear free of spin. likewise, perceptions of the reliability of firms ’ financial statements are increasingly reflected in yield spreads on corporate bonds. corporate governance has doubtless already measurably improved as a result of this greater market discipline in the wake of recent events. but the congress is clearly signaling that more needs to be done. i hope that any legislative and regulatory initiatives will move to further realign current practice with the de jure governance model that served us well in generations past. most success in that direction would seem to come primarily from changes in incentives for corporate officers. in particular, as president bush has suggested, defining more clearly the duties of ceos with respect to accounting and disclosure appears appropriate. there are, doubtless, other measures that could reinforce the aforementioned enron - induced market incentives for disclosures and thereby strengthen investors ’ trust, which is so essential to the effective functioning of free - market capitalism. we have to be careful, however, not to look to a significant expansion of regulation as the solution to current problems, especially as price - earnings ratios increasingly reflect the market ’ s perception of the quality of accounting. regulation has, over the years, proven only partially successful in dissuading individuals from playing with the rules of accounting. * * * some changes, however, appear overdue. in principle, stock - option grants, properly constructed, can be highly effective in aligning corporate officers ’ incentives with those of shareholders. regrettably, the current accounting for options has created some perverse effects on the quality of corporate disclosures that, arguably, is further complicating the evaluation of earnings and hence diminishing the effectiveness of published income statements in supporting good corporate governance. the failure to include the value of most stock - option grants as employee compensation and, hence, to subtract them from pretax profits, has increased reported earnings and presumably stock prices. this would be the case even if offsets for expired, unexercised options were made. the financial accounting standards board proposed to require expensing in the early to middle 1990s but abandoned the proposal in the face of significant political pressure. the federal reserve staff estimates that

, this trend in corporate leverage will bear watching. for the time being, at any rate, financial conditions are providing ample support for both corporate investment and household spending around the world. turning to the outlook for domestic demand, the very high rates of growth of business investment are now probably behind us, but the current high levels of investment are adding to the capital stock in a way that should, in time, ease capacity constraints. governments in several states, conscious of the need for public infrastructure, are also looking to expand investment. there appears to be considerable competition for the resources needed to complete all these projects. a gradual expansion in residential construction activity will probably get under way over the next year. we expect household consumption will grow at about trend in the period ahead. in both these areas, our expectations take into account the fact that the impact of the monetary policy adjustments made last year are still working their way through the household sector. all of this should mean that domestic demand will rise at, or slightly below, trend pace over the coming year. with some export sectors expanding as additional capacity comes on line, our central forecast is for growth in non - farm gdp to pick up to about trend during the next couple of years. total gdp growth will be lower in the near term because of the drought ’ s effect on the farm sector. if rainfall patterns improve in the months ahead, there would presumably be some recovery in farm production during 2007 / 08, though the likelihood of that, let alone its strength, is inevitably highly uncertain at this stage. so far as the outlook for inflation is concerned, at the time of our november 2006 statement on monetary policy, after the three policy adjustments made last year, we believed there were grounds to think that the higher inflation outcomes observed up to that time would moderate a little in the period ahead. we were, admittedly, a little tentative in that judgement, but based on that assessment, the board elected to leave interest rates unchanged in december. at our most recent meeting two weeks ago, we felt we could be a little more confident in that inflation forecast. we will, of course, see some large movements in cpi inflation in the next few quarters. it will probably fall noticeably below 2 per cent on an annual basis, as falling petrol and banana prices have their effect. after that, it will rise again, as those temporary factors fade, and we currently expect that cpi inflation will be around 2¾ per cent by early 2008, remaining around that rate thereafter. that