association index of applications for home purchase suggests that demand has been fairly steady through early april. also, mortgage rates are still at historically low levels, and mortgages to prime borrowers and fixed - rate mortgages to all classes of borrowers continue to show low rates of delinquency. the second major area of concern in the near - term outlook, and one that perhaps could pose noticeable downside risks, is business investment. real outlays for new equipment and software weakened in the final quarter of 2006, and the recent data on orders and shipments of nondefense capital goods suggest that the softness in demand has extended into early this year. part of the weakness can be clearly traced to a decline in demand for investment goods that are used heavily in residential construction. in addition, demand for goods used by the motor vehicle industry also has softened of late. but, demand for other types of non - high - tech business equipment also appears to have slowed recently, raising more fundamental questions about business views on the current and prospective environment for capital spending. to be sure, the pace of output has moderated, which typically would lead to some deceleration in capital spending. but the magnitude of the recent pullback seems to be greater than would be expected. adding to the puzzle has been a weakening in demand for non - high - tech equipment even as financial conditions for investment have remained generally favorable. in particular, business balance sheets are strong, and although profits have slowed, profit margins remain elevated. interest rates and credit spreads are relatively low, and firms appear to have ample ability to raise funds at a reasonable cost. the unwillingness of businesses to invest might be due to concerns about the prospects for long - term productivity growth and the expected rate of return on capital investment. moreover, businesses may be anticipating a more pronounced deceleration in sales than would be consistent with the moderate expansion that i am expecting. respondents to the blue chip economic indicators survey suggest that the recent reluctance to invest reflects greater uncertainty about the outlook for sales and earnings. if so, the continuation of a moderate economic expansion is likely over time to restore confidence and lead to a firming in business investment. not all of the recent news on business spending has been to the downside, however. demand for high - tech equipment appears to have picked up early this year after leveling off in the final quarter of 2006. demand for computers, which was likely boosted by the introduction of the windows vista operating system, seems to

3 percent rate for the past two years. whether a pickup in nominal labor compensation will lead to upward pressure on inflation will depend on several factors. importantly, an acceleration in compensation might be offset by higher labor productivity ; indeed, during most of this expansion, strong gains in labor productivity have checked the rise in unit labor costs. and, with profit margins wide, businesses might accommodate increases in labor compensation without passing them on to consumers in the form of higher prices. in these circumstances, gains in nominal compensation for workers would translate into gains in real compensation. so how is labor productivity doing? during the first three years of the current expansion, output per hour in the nonfarm business sector rose 3 percent per year ; in the past two years, it has decelerated to 2 percent. i suspect that this slowdown does not represent a fundamental weakening in the longerrun trend, but is rather a normal cyclical transition from an above - trend rate of increase to a more sustainable rate. of course, i also recognize a potential downside risk to the outlook for productivity, especially given the weakness in business investment that i noted earlier. nonetheless, averaging through the entire expansion to date, the underlying rate of productivity advance still seems to be close to the 2 - 1 / 2 percent rate that has prevailed since the mid - 1990s. more fundamentally, i believe that long - run inflation expectations remain a key determinant of the path of inflation. but what are the current expectations for long - term inflation? unfortunately, that is not an easy question to answer. the results from the survey of professional forecasters, readings on household opinion such as the reuters / michigan survey, and the spread between standard treasury securities and treasury inflation - protected securities – taken together – suggest that long - term inflation expectations are currently around 2 percent, although this guess is far from certain. given my estimate of the current level of long - run inflation expectations as well as the likelihood of some easing of resource pressures in labor and product markets, i expect that core inflation will slow to around 2 percent over the next couple of years. although i believe that inflation expectations will play a primary role in determining the course of inflation, i want to emphasize that neither economists nor policymakers understand the expectations - formation process very well. however, one aspect of expectations formation that we have come to regard as crucial is the credibility of monetary policy. consistent with its dual mandate to foster maximum sustainable employment and price stability, the fed must therefore continue to respond