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

thus dramatically pushed up the participation rate. indeed, by some estimates, the increase in the labor force participation of women aged sixteen years and older added a little more than 1 / 2 percentage point per year to the growth rate of potential output between the late 1960s and the early 1990s. now, the united states is facing another change in the trend of labor force participation. the baby boomers, the large population born between 1946 and 1964, are getting older, and the oldest are turning sixty this year. older individuals tend to have relatively low participation rates, with many people starting to retire in their fifties and more still when they reach sixty and then sixty - five. thus, with the aging of the boomers, a large share of the population is entering the low - participation years, which will tend to pull down the aggregate labor force participation rate. recent work by economists at the federal reserve board has explored how changes in the age distribution of the population affect the participation rate. for instance, between 1995 and 2005 the participation rate declined on net from 66. 4 percent to 66. 0 percent. the study suggests that changes in the age distribution of the population - the movement of a large portion of the population from their high - participation - rate years to their later, low - participation - rate years - can explain the bulk of the decline. 1 the changing age distribution - primarily the aging of the baby boomers - is expected to lower the participation rate by about 0. 2 percentage point next year and continue to lower it over the next several years. however, this decomposition assumes that the participation rate for each age group is constant at its average between 1995 and 2005. but the propensity of individuals of a given age to participate in the labor force changes over time. already, individuals aged fifty - five and older are working more than they did ten years ago, perhaps because of better health ; higher levels of education ; and a reduction, over time, in the share of workers employed in physically strenuous occupations. unfortunately, there is still much we do not understand about the increase in the participation rates of older workers, so it is difficult to predict how much their participation will rise in the future. however, given the magnitude of the predicted age - related decline, it is unlikely that changes in behavior could completely offset it. as i noted earlier, the reduction in the growth of the labor force and, thus, of potential output has important implications for how we interpret incoming economic data. for example,