last year offset the pressure from rising compensation gains on labor costs per unit of output. and non - labor costs, which are roughly a quarter of total consolidated costs of the nonfinancial corporate sector, were little changed in 1996. owing in part to this subdued behavior of unit costs, profits and rates of return on capital have risen to high levels. as a consequence, a substantial number of businesses apparently believe that, were they to raise prices to boost profits further, competitors with already ample profit margins would not follow suit ; instead, they would use the occasion to capture a greater market share. this interplay is doubtless a significant factor in the evident loss of pricing power in american business. intensifying global competition may also be limiting the ability of domestic firms to hike prices as well as wages. competitive pressures here and abroad should continue to act as a restraint on inflation in the months ahead. in addition, crude oil prices have largely retraced last year ’ s run - up, and, with the worldwide supply of oil having moved up relative to demand, futures markets project stable prices over the near term. food prices should also rise less rapidly than they did in 1996 as some of last year ’ s supply limitations ease. nonetheless, the trends in the core cpi and in broader price measures are likely to come under pressure from a continued tight labor market, whose influence on costs will be augmented by the scheduled increase in the minimum wage later in the year. and, with considerable health - care savings already having been realized, larger increases in fringe benefits could put upward pressure on overall compensation. moreover, although non - oil import prices should remain subdued in 1997 as the sharp rise in the dollar over the past year - and - a - half continues to feed through to domestic prices, their damping effects on u. s. inflation probably will not be as great as in 1996. the lagged effects of the increase in the exchange value of the dollar will also likely restrain real u. s. net exports this year. in addition, declines in real federal government purchases should exert a modest degree of restraint on overall demand, and residential construction will probably not repeat the gains of 1996. on the other hand, financial conditions overall remain supportive to the real economy, and creditworthy borrowers are finding funding to be readily available from intermediaries and in the securities markets. moreover, we do not see evidence of widespread imbalances either in business inventories or in stocks of capital equipment and consumer

that productivity growth, the basis for increases in earnings, is beginning to pick up. i also suspect earnings expectations and equity prices in the united states were primed to adjust. the currency crises in southeast asia and the declines in equity prices there and elsewhere do have some direct effects on u. s. corporate earnings, but not enough to explain the recent behavior of our financial markets. if it was not developments in southeast asia, something else would have been the proximate cause for a re - evaluation. while productivity growth does appear to have picked up in the last six months, as i have pointed out in the past, it likely is overly optimistic to assume that the dimension of any acceleration in productivity will be great enough and persistent enough to close, by itself, the gap between an excess of long - term demand for labor and its supply. it will take some time to judge the extent of a lasting improvement. regrettably, over the last year the argument for the so - called new paradigm has slowly shifted from the not unreasonable notion that productivity is in the process of accelerating, to a less than credible view, often implied rather than stated, that we need no longer be concerned about the risk that inflation can rise again. the federal reserve cannot afford to take such a complacent view of our price prospects. there is much that is encouraging in the recent performance of the american economy, but, as i have often mentioned before, fundamental change comes slowly and we need to evaluate the prospective balance of supply and demand for various productive resources in deciding policy. recent developments in equity markets have highlighted growing interactions among national financial markets. the underlying technology - based structure of the international financial system has enabled us to improve materially the efficiency of the flows of capital and payment systems. that improvement, however, has also enhanced the ability of the financial system to transmit problems in one part of the globe to another quite rapidly. the recent turmoil is a case in point. i believe there is much to be learned from the recent experience in asia that can be applied to better the workings of the international financial system and its support of international trade that has done so much to enhance living standards worldwide. while each of the asian economies differs in many important respects, the sources of their spectacular growth in recent years, in some cases decades, and the problems that have recently emerged are relevant to a greater or lesser extent to nearly all of them. following the early post - world war ii period, policies generally fostering low