Even with all of the forward momentum in the domestic economy, there are few signs so far that inflationary pressures are building to any significant extent. Indeed, as Chairman Greenspan noted here this morning, inflation remains low, if not declining. That, in itself, is remarkable, given the length and pace of the expansion and the relatively low level to which the unemployment rate has been driven.

The real proof comes not in these backward-looking measures, but in forward-looking indicators, and inflation expectations over the next five years remain remarkably low. The University of Michigan's survey of consumer sentiment finds that inflation expectations have continued to edge down over the past year despite the low level of the unemployment rate.

Why has the recent inflation experience been so favorable? Many observers of labor markets believe that the Nonaccelerating Inflation Rate of Unemployment (NAIRU) the theoretical level of unemployment below which the economy generates inflation has fallen in recent years, to around 5-1/2 percent or perhaps even less. A lower NAIRU implies less inflationary pressure for any given level of the actual unemployment rate.

Another factor that has probably played a role in the recent low inflation results has been the healthy pace of productivity growth over the past two years or so. There are even some hints in the data that trend productivity may be inching up, boosted by strong investment spending. Indeed, output per hour as officially measured, using the output side of the national income and product accounts, has risen at a 1.3 percent annual rate since the business cycle peak in the third quarter of 1990 slightly faster than the 1.1 percent trend rate of growth since 1973. And if calculated (as it used to be) using data from the income side of the national accounts, productivity has risen at a 1.5 percent annual rate since the 1990 peak.

As a result of the strong economy, as well as President Clinton's 1993 deficit reduction package and the bipartisan budget package enacted in 1997, we have just recorded the first budget surplus in 29 years. The Federal budget deficit, which reached an all-time high of $290 billion in fiscal year 1992, is no more. Thanks to a commitment to fiscal discipline and the strong economy, the Federal government ran an estimated $70 billion budget surplus in fiscal year 1998. This is no small accomplishment.

The longer-run fiscal outlook is also encouraging, with surpluses forecast as far as the eye can see. I never thought I would see the day when serious market commentators furrowed their brows over the issue of whether there would be sufficient supplies of Treasury securities to support a deep and liquid market.

One long-run challenge that we do face is dealing with the demographic strains on the Social Security system, but as many of you know, President Clinton has made clear his determination to address this issue now, and to reserve the budget surpluses, in their entirety, until we have arrived at a solution. Indeed, the President is prepared to veto any bill the Congress sends him that would threaten to squander the surplus before Social Security reform is in place. The Administration's position on this issue is easy to remember, because it is summed up in the simple phrase that the President first used in his State of the Union Address earlier this year: "Save Social Security First."

The lesson I take away from all of this is that, if we must enter a period of heightened global financial turmoil and greater macroeconomic risk, which we clearly are doing, then we are starting from a remarkably favorable position. Output and employment are at a high level and retain forward momentum. Inflation is under control. A major step toward getting our fiscal house in order has been taken, with the achievement of the first balanced budget in 29 years. And a process for shoring up the long-term finances of the Social Security system has been put in place.

That said, the financial and international environment clearly has grown less hospitable of late, and poses decided risks to our economy. Indeed, we concur with the 57 percent of respondents to the latest NABE Economic Policy Survey who identify fallout from the international financial crisis as posing the most serious risk to the U.S. economy.

Beginning with the devaluation of the Thai baht in July 1997, Asia, Russia, and, more recently, Latin America have come under varying degrees of financial pressure. At the same time, the situation in Japan has deepened in severity. The effect on the U.S. has evolved slowly, and although it is too early to know for sure what the ultimate scope of that impact will be, it is clear if this question had ever been in doubt that the effects on our economy will be important.

Thus far, the most noticeable effect on the domestic real economy has been on our balance of trade. The continued strength of the U.S. economy relative to the rest of the world most notably East Asia has led to a significant increase in our current account deficit. Thus far, the shift in the balance of trade has mainly been a story about exports. Indeed, total U.S. exports in real terms actually declined 2.8 percent at an annual rate in the first quarter of this year, and 7.7 percent at an annual rate in the second a sharp contrast to the almost 10 percent average annual growth in real exports over the preceding four years. Meanwhile, real imports into the United States have not accelerated thus far; in fact, they rose at a slightly slower pace in the first half than they did in 1997.

Overall, the decline in net exports took about 2 percentage points off the growth of real GDP in the United States in the first half of this year. And while we expect that effect to diminish going forward, we agree with the majority of respondents to the NABE Survey forecast who expect that our trade deficit will remain a net drag on the macroeconomy for at least the next few quarters. Moreover, if the turmoil continues to spread, we run the risk of additional impact on our economy.

A fascinating aspect of the last year or so is that several aspects of the international situation acted to buffer the American economy from what could have otherwise been a more severe impact. Interest rates have been lower, giving a boost to home building and car buying. And import prices and oil price have been lower than they otherwise would have been, helping to hold down our overall inflation rate.

More recently, however, some aspects of this situation have become less benign. For example, as Chairman Greenspan discussed with you at some length this morning, yield spreads between Treasuries and other securities have widened, in some cases dramatically. This appears to reflect both an increased appetite for liquidity, pure and simple, and an increased aversion to credit risk.

Evidence of the impact of the global financial crisis on the U.S. economy as well as other economies throughout the world underscores the importance of Congress approving full funding for the International Monetary Fund. Failure to do so puts American prosperity at risk. As we face what could be the world's greatest economic challenge in half a century one in which the nations of the world are looking to the United States for leadership disengaging from the increasingly interdependent global arena simply ought not be an option. As President Clinton said last month: "History teaches us that at a time of worldwide difficulty, it would be folly to retreat into a protectionist shell."

Let me conclude by commenting briefly on the near term economic outlook for the United States. The sharp downward adjustments taking place in many foreign economies and the widespread appreciation of the dollar in recent years are leading to expectations for moderated growth rates in the U.S. economy.

Such a tempering in growth does not on its face pose a major threat to the longevity of the current expansion and has, in fact, been expected for some time now. Let me be clear: Although the precise impact of the global financial crisis on the U.S. economy is at this point uncertain, the latest evidence available to us makes a strong case that the current expansion will continue. The unemployment rate continues to hover at historically low levels. And corporate balance sheets remain generally healthy, with high profit levels relative to interest costs and manageable debt.

With inflation in both the U.S. and other G-7 countries as a whole low, and in some cases declining further in recent months, there is clearly latitude to focus on what President Clinton has identified as the number one priority, namely generating sustainable and appropriate growth.

At the same time, we expect to stay on the responsible path of strict fiscal discipline charted by this Administration almost six years ago. According to the Office of Management and Budget's Mid-Session Review, the budgetary outlook is bright. OMB forecasts that the surplus will grow over the next four years to $148 billion by 2002. By 2008, OMB forecasts a surplus of just over $340 billion. Such surpluses would likely lead to higher savings and investment and continued low interest rates. Moreover, provided we can maintain the kind of fiscal discipline that we've been able to muster over the past few years, there is every prospect of continued sound fiscal policy for many, many more years.

The current strength of the U.S. economy is in large part the result of a combination of sound policies: deficit reduction, open markets, and investing in our people. Our commitment to these sound policies benefits both our domestic economy and the global economy. With the fundamentals of the U.S. economy strong and with an outlook for continued strength in the domestic economy the United States is in a position both to continue to generate solid economic growth at home and to play a leading role by working with industrialized and emerging nations, as well as the international financial institutions, to encourage responsible reforms and measures to stem the tide of the contagion effect in economies around the world.