but those sources of strength probably will be tempered by other influences. as we noted in february, because consumer and residential expenditures did not decline during the overall downturn, there is little pent - up demand to be satisfied. consequently, a surge in household spending early in this recovery is unlikely. moreover, the declines in household wealth that have occurred over the past couple of years should continue to restrain spending in the period ahead. still, despite concerns about economic prospects, equity valuations, terrorism, and geopolitical conflicts, consumers do not appear to have retrenched in retail markets. indeed, consumers responded strongly to the new interest rate incentives of motor vehicle manufacturers this month. early reports indicate a significant improvement in sales over june. by contrast, business spending has been depressed. the recent economic downturn was driven, in large measure, by the sharp falloff in the demand for capital goods that occurred when firms suddenly realized that stocks of such goods - - both those already in place as well as those in inventory - - were excessive. the resulting declines in the production of capital goods were particularly sizable in the high - tech sector. monthly shipments of computers and peripherals, for example, fell by about 40 percent from their peak in 1999 through their trough in 2001. sales by communications equipment producers slumped just as sharply. outside the high - tech sector, production also declined. assemblies of commercial aircraft slowed abruptly. in addition, the construction of office and industrial buildings fell off noticeably. the collapse of many internet firms and the difficulties of the high - tech sector more generally led to a significant drop in the demand for office space that was exacerbated as the economic slowdown widened beyond the tech sector. overall, the level of real business fixed investment plunged about 11 percent between its quarterly peak in the final months of 2000 and the first quarter of this year. with the adjustment of the capital stock to desired levels now evidently well advanced, business fixed investment may be set to improve. a recovery in this category of spending is likely to be gradual by historical standards and uneven across sectors. for example, an upturn in production of semiconductors and computers has been under way now for nearly a year, but with significant overcapacity still prevailing in some segments of the telecom industry, investment in communications equipment is likely to remain subdued for some time to come. overall capital expenditures should strengthen with time. in particular, firms should respond increasingly to the expected improvement in the outlook for sales and profits, low debt

financing costs, the heightened incentives resulting from the partial expensing tax provisions legislated earlier this year, and especially the productivity enhancements offered by continuing advances in technology. indeed, despite the recent depressed level of investment expenditures, the productivity of the u. s. economy has continued to rise at a remarkably strong pace. in the nonfarm business sector, output per hour is currently estimated to have soared at an average annual rate of about 7 percent over the fourth quarter of 2001 and first quarter of 2002, and the available evidence points to continued gains last quarter - - though not at the frenetic pace of the preceding half year. in part, these increases in productivity reflect the very cautious attitudes of managers toward hiring. but the magnitude of the recent gains would not have been possible without ongoing benefits from the rapid pace of technological advance and from the heavy investment over the latter half of the 1990s in capital equipment incorporating such advances. despite these encouraging developments regarding the longer - term prospects for the economy, financial markets have been notably skittish of late, and business managers remain decidedly cautious. in part, these attitudes reflect the lingering effects of the shocks that our economy endured in 2000 and 2001. particularly given the dimensions of those shocks, some persistent uncertainty and concern are not surprising. also contributing to the dispirited attitudes among many corporate executives is the intensely competitive business environment facing their firms. increased competition, while producing manifold benefits for consumers and for the economy as a whole, clearly makes individual firms'operations more difficult. past deregulation and, more recently, the enhanced speed and efficiency of information flows resulting from technological advances are strengthening competition domestically. in addition, globalization is intensifying competition in a broad range of markets and damping pricing power across developed and developing nations alike. those businesses where heightened competition has engendered a loss of pricing power have sought ways to raise profit margins by employing technology to lower costs and improve efficiency. in the united states, as a consequence of the interaction of monetary policy, globalization, and costreducing productivity advances, price inflation has fallen in recent years to its lowest level in four decades, as has the recent growth rate of nominal gdp and consolidated corporate revenues. in part because nominal corporate revenues, although no longer declining, are growing only tepidly, managers seem to remain skeptical of the evidence of an emerging upturn. profit margins do appear to be coming off their lows registered late last year, but, unsurprisingly