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CHICAGO – Even though the “road to recovery has been bumpier than expected,” Federal Reserve Bank of Chicago President Michael Moskow is optimistic that the economy will regain momentum through the end of this year and into 2004. Moskow recently spoke to 130 attendees at CUNA’s Economic and Investment Conference. The annual conference targets CEOs, CFOs and other staff looking for solutions to managing finances during a shaky fiscal environment. Despite layoffs and industry downturns, Moskow said “our long-term prospects are bright,” optimistic that the U.S. economy “has proven itself resilient and dynamic, driven by an entrepreneurial culture, market-based principles and continuing technological advances. He also said that while “solid productivity trends, fiscal stimulus, and low interest rates have laid the groundwork for stronger growth, corporate governance issues and geopolitical events have left many business managers with a diminished appetite for risk.” Moskow serves on the Fed’s key policymaking group, the Federal Open Market Committee (FOMC), chaired by Alan Greenspan that sets monetary policy and reports on regional economic conditions and policy recommendations for the national economy. Present-day conditions can be traced back to the period between 1991 and 2001, when the U.S. economy “enjoyed its longest expansion of the post-World War II era,” Moskow explained. According to the National Bureau of Economic Research, widely acknowledged as the arbiter of business cycle dating, that expansion ended in March 2001 and the economy entered a recession, Moskow said. Even thought the recession was a “mild” one and increased household spending helped to cushion it, those “blessings during the recession has complicated the recovery.” “Typically, as output begins to expand again, pent-up demand and rising inventory investment contribute to a surge in growth that is markedly above trend,” Moskow explained. “For example, after the deep recessions in the early 1980s, (the) Gross Domestic Product (GDP) jumped up at annualized growth rates between 7 and 9% in some quarters. But, this has not been the case since GDP began to increase again in the fourth quarter of 2001, in part because there is no pent-up demand for vehicles, homes, and many other cyclical goods.” Looking ahead to the second half of the year and into 2004, there are reasons to be optimistic for stronger growth, Moskow said, including indications that “market dynamics should stimulate activity and strong productivity gains have kept real personal incomes rising throughout this time of sluggishness and should continue to be a key foundation for growth into the future.” Fiscal policy should also stimulate growth, Moskow said. With the Bush Administration tax cuts scheduled to take effect this summer, nearly $50 billion will go to consumers and businesses by the end of this year, with close to $100 billion more expected in 2004. He also acknowledged that while “terrorism remains a real concern, companies have been tightening their security and taking steps to reduce the potential impact of any new attacks.” On the corporate governance front, many issues continue to be addressed by various regulatory agencies and by increased diligence in corporate offices and boardrooms. “Many of the factors that have hindered business spending – including worries about terrorism, corporate governance issues, and excess capacity – should have a diminishing impact moving forward,” Moskow said. Appreciable amounts of excess capacity exist with some businesses but this will change over time because depreciation for such items as computers and other high-tech investments will cause the reduction in excess of inventory, Moskow said. Given the current conditions, the Fed is expecting growth to pick up during the second half of the year and into 2004. In the Fed’s recent Monetary Policy Report to Congress, the central tendency forecast calls for real GDP to rise 2-1/2 to 2-3/4% this year and even faster growth in 2004. Private sector economists are forecasting growth to average 3.7% during the second half of 2003, up from 1.6 percent in the first half. Moskow said while “it is important to remember that the economy always faces risks of shocks – in both positive and negative directions,” on the upside, business sentiment could rebound more dramatically than we expect, producing a pop-up in spending.” “On the downside, there is the risk that consumer spending could lose its forward momentum or, residential investment could pull back substantially from its red-hot level,” he warned. Speaking on the Fed’s decision in June to cut the federal funds rate by 25 basis points, to 1%, Moskow said “what matters most in purchasing decisions is not the nominal interest rate, but rather the real interest rate-that is, the nominal rate less the expected rate of inflation.” “The nominal interest rate determines the number of dollars a borrower must pay back on a loan, the expected rate of inflation represents the perceived decline in the purchasing power of those dollars over time,” he said. “So the real interest rate determines how many real resources a borrower must pay tomorrow for taking out a loan today.” -

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