Another possibility is that business investment has been held down in recent years because relative prices of capital goods are no longer falling at the same pace at which they declined in the late 1990s.

Businesses were unusually cautious after the most recent recession in expanding their productive capacity. Both hiring and capital investment lagged the usual recovery pace. One possible source of this caution was said to be questions about the strength and sustainability of the recovery, accentuated by concerns about terrorism and other geopolitical uncertainties.

During 2001 and 2002, anecdotal reports suggested that many firms saw no need to upgrade equipment because no compelling new technology or application had been released, which would have tended to lengthen the replacement cycle. If replacement cycles since then have remained longer than in previous decades, firms would respond with a lower level of gross investment.

The latest reads on business spending and intentions point to continued solid growth in capital spending, supported by favorable fundamentals of steady increases in final demand and a relatively damped cost of capital.

We cannot say exactly why the level of investment has remained low for the past few years, so we certainly cannot rule out a return to previous higher trends. In that regard, we do seem to be seeing a strengthening in global demand, which could signal a more pervasive change in attitudes and expectations.

Productivity growth since 2000 has averaged 3.3 percent per year, which incidentally would double average incomes in less than 21 years. This is an astonishing performance over a time period with significantly lower rates of capital formation than in the late 1990s. Thus, recent productivity gains appear to owe somewhat more to the re-organization of business processes than to the application of additional capital. But as business investment continues to grow, productivity growth is likely to be driven more by capital formation. We should therefore pay special attention to current prospects for investment spending.

The fundamentals for investment are encouraging. In the high-tech area, we are still seeing declining relative prices for many products. Business sales are strong. New orders for capital equipment have been on a pronounced uptrend for 2 ½ years. The cost of capital remains favorable. Capacity utilization in manufacturing has recovered from the recession and any capital overhang is largely behind us. And business profitability is unusually high. Putting these all together, I expect investment spending to be quite robust this year. Falling relative prices should continue to support technology upgrades that enhance efficiency for many firms. In addition, rising capacity utilization rates suggest that many firms will need to add capacity to keep up with demand growth. And if I am correct, this capital spending should be enough to support overall demand in the economy, even as the housing market cools down.

I expect businesses to continue their 2005 solid pace of spending on equipment and software, as at least some of the capital goods acquired in the spending boom of the late '90s are replaced and new capacity is added. Clearly, the “fundamentals” for investment spending -- expectations of productivity growth, overall business profitability, and accommodative debt and equity markets -- are there.

While continued growth in the share of output devoted to business investment seems highly probable, it is difficult to foresee with any certainty the scale of investment that businesses will find profitable to undertake, so spending growth in this category could well deviate from expectations.

One implication of this perspective on recent productivity trends is that the current expansion in business investment is laying a foundation for future growth in total factor productivity, and thus provides at least some grounds for optimism that productivity growth might come in at 2.5 percent or higher, rather than the long-run trend rate of 2.25 percent.

In the business sector, investment in new equipment continues to expand at a good clip, boosted by robust sales as well as ongoing replacement and upgrading needs. In addition, as I'll discuss in a moment, corporate financial conditions are favorable for investment.

The growth of profits and the related buildup of cash have been broadly distributed across industries. And with the sound corporate financial positions, credit spreads remain narrow, and bank lending terms remain favorable. These beneficial financial conditions, combined with rising utilization rates, bode well for further increases in business capital expenditures.

Despite the upheavals in several sectors of the economy, such as the auto industry, business investment is also expected to contribute to growth in 2006.  Strong growth of corporate earnings combined with low borrowing costs over the past two years have led to marked improvements in firms' balance sheets...Looking ahead, while there may be some slowing from recent performance, most private sector forecasters expect profit growth will provide fundamental support for investment spending.

The fundamentals for business investment in equipment and software look quite sound. Business output is expanding steadily and real funding costs are relatively low, both because inflation-adjusted, risk-free rates have been low and because corporate risk spreads are relatively narrow. Evidently, there has been a sufficient flow of opportunities to deploy new capital profitably. Business investment in equipment and software has grown at over 11 percent in real terms since the first quarter of 2003, and it appears poised to grow at rates almost that strong next year.

I expect businesses to continue contributing significantly to the overall increase in spending. With the expansion firmly in place, businesses are investing again in high-tech hardware and software, and in warehouses and machinery as well...Going forward I anticipate that growth in business investment spending overall will continue to play a major role in aggregate economic growth.