First, household saving behavior does not seem to have changed in any fundamental way. What has changed to a degree is the trend in asset values. Households have consumed some of the increase in asset values in about the same way they always have.

My second tentative conclusion is that the behavior of households, though perfectly sensible and responsible for households as a whole, has led to a situation in which the United States as a whole is saving too little of its national output. U.S. domestic investment has not suffered, because capital has been flowing into the United States from abroad. However, at some point the U.S. net international investment position will stop becoming ever more negative. U.S. saving will then finance a larger fraction of U.S. domestic investment and, perhaps, repurchase some U.S. assets now held by international investors. There is no reason why this adjustment should be difficult or disorderly, but it will require that U.S. consumption outlays expand more slowly than U.S. GDP for a time. 

The outlook for real growth in 2007, then, is for continued strength in consumer spending and business investment to be partially offset, particularly early next year, by the drag from the housing market.  Growth will start the year on the low side, but should be back to about 3 percent by the end of next year.  So my best guess right now is that real GDP growth will average between 2 ½ and 2 ¾ percent in 2007. 

Rising disposable incomes should enable household spending to expand at a moderate pace and provide continued support for the overall economic expansion.

Therefore, the rapid pace of house price appreciation in recent years likely contributed to the decline in the saving rate.  Similarly, the cooling of the housing market and associated reduction in capital gains on housing will probably provide some upward impetus to the saving rate.  Even so, as I said in my testimony, rising disposable incomes should enable household spending to expand at a moderate pace and provide continued support for the overall economic expansion.

As it has become easier and easier to tap into that wealth, people have felt less of a need to save from current income. But with the softening in house prices acting to slow consumers' accumulation of wealth, the urge to save rather than spend may resurge. In fact, consumer wealth is getting another hit from the recent declines in the stock market, which also may induce people to build up savings. So, the very low—in fact, negative—saving rate makes the chance of a sizeable drop-off in consumer spending seem larger than the chance of a big surge.

Despite the increased complexity of financial products and the wider availability of credit in many forms, U.S. households overall have been managing their personal finances well. On average, debt burdens appear to be at manageable levels, and delinquency rates on consumer loans and home mortgages have been low. Measured relative to disposable income, household net worth is at a fairly high level, although still below the peak reached earlier this decade.

The sectors of the economy that will support our economic growth this year are expected to be somewhat different from those that prevailed in the past few years. The housing market, after several years of strong expansion, is already showing signs of cooling off this year. Consumer sentiment has been deteriorating, according to the latest survey responses, and recent data show signs that consumer spending is softening from its strong first-quarter performance.

Consumers have sustained their spending during the past several years, in part, by cashing out some of their home-equity dollars. This extra source of financing is likely to slow down in a softening housing market. Fortunately, though, I expect to see enough employment and income growth coming out of the labor market to keep consumer spending advancing at a moderate rate.

As home price escalation slows, consumers can be expected to feel less confident about gains in wealth and may well begin to feel inclined to save more and spend less. These indirect effects of a housing slowdown are embedded in my forecast of some slowing in the growth of consumer spending.

The process of adjustment that appears to be underway in the U.S. housing market, occurring as it is after a sustained and very substantial decline in the household savings rate, provides more than the usual challenge in predicting the future strength of consumer spending.

The last recession was a mild one partly because these financing innovations continued to facilitate the growth in mortgage lending and refinancing, supporting growth in residential investment and household consumption during the downturn and early recovery.

With oil prices persistently above $70 a barrel, households and businesses face new costs that must be absorbed, offset, or passed along if possible. Although difficult to measure, these higher energy costs have forced households to reallocate spending and could dampen consumer spending in the future.

The Fed's gradual removal of monetary policy accommodation should tend to damp the pace of activity. This effect is likely to be reinforced by a related development—a significant moderation in the rate of appreciation of house prices. This could well restrict not only the pace of residential construction but also the pace of consumer spending.

So far, at least, the near doubling of energy prices has not been reflected in slower consumer spending—possibly because of a stimulatory offset from rising house prices. My assumption, based on the forecasts embodied in futures markets, is that energy prices will stabilize around their current levels. If so, the negative effect on spending should dissipate over 2006, and, as it does, this would actually contribute to higher overall economic growth.

I am increasingly concerned about the well-known long and variable lags in monetary policy—specifically, that the delayed effects of our past policy actions might impact spending with greater force than expected. This could show up especially in the housing market and via housing prices and balance sheet effects on consumer spending. While I expect the housing sector to slow somewhat, I will be highly alert to the possibility of the policy tightening going too far.