Reinforcing this tendency to curtail capital outlays was a deterioration in the financial conditions of businesses: Profits sagged and decreasing equity prices and widening risk spreads inhibited access to external funds. Heightened geopolitical risks after the terrorist attacks of September 11 and in the run-up to the Iraq war added to businesses’ caution. In the last several quarters, these restraining forces have been abating.
The excess physical capital that had developed earlier appears to have been worked off in most sectors, and the need to replace older equipment has become more pressing. At the same time, the financial condition of businesses has improved considerably; their profitability and cash flow have surged, and low interest rates have facilitated a restructuring of their balance sheets.