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.

[B]usiness fixed investment posted a slight decline in the fourth quarter. I suspect that the decline was nothing more than normal variation, perhaps a consequence in part of firms waiting for release of the new Vista operating system from Microsoft.

The fundamental underpinnings of near term investment demand are encouraging. Profitability is high, capacity utilization has been steadily rising, and many firms see strong demand for their products. Thus, it is not surprising that new orders for capital equipment increased 7.5 percent over the last year, and I see a solid outlook for capital spending over the next several quarters.

The factors working to support growth include ongoing strength in business demand, fueling relatively rapid growth in spending on business investment in equipment and software, including the important high-tech industries. Moreover, spending for the construction of nonresidential structures has advanced smartly so far this year, and promises to remain strong for a while longer. For example, outlays on drilling and mining structures have continued to increase in response to oil prices that are still high and expected to remain so. Furthermore, fundamentals in commercial real estate markets continued to improve this year, increasing demand for commercial space from office parks to warehouses.

The effects on economic activity of a deceleration in consumption spending are likely to be offset to some extent by a pickup in demand from other sectors. In addition to the boost to construction spending from rebuilding efforts, the growth of business capital spending more broadly should strengthen....   Looking ahead, some of the restraining influences on investment spending appear likely to wane. Production and the demand for capital likely will strengthen with the turn in inventory investment; several foreign economies, such as Japan, seem to be experiencing more robust demand; and any tendency toward more-settled conditions in energy markets would help to alleviate uncertainty about both foreign and domestic demand.