U.S. Economy Contracts, Signaling Recession

The U.S. economy shrank by 0.3 percent during the third quarter, as consumers reined in their spending, the Commerce Department said Thursday. It was the latest evidence of the toll the credit crunch and housing downturn have taken on growth.

The decline was somewhat smaller than most economists had expected but still represented a significant drop from the second quarter, when the economy expanded by 2.8 percent. Only a ramp-up in government spending kept the economy from shrinking even more, according to the Commerce Department.

Stock prices rose after the report's release, perhaps because most investors were expecting an even bigger drop in GDP. The Dow Jones industrial average closed up 189 points at 9,180.

"The key takeaway from the report is that the signals for private-sector spending were almost all negative," wrote Nigel Gault, chief U.S. economist for Global Insight. Residential construction and business equipment spending declined, while exports slowed, he noted.

Perhaps the most worrisome part of the report was a 3.1 percent decline in consumer spending, the sharpest drop since 1980, he said. Consumer spending typically accounts for two-thirds of U.S. economic activity and has an outsized impact on growth. Disposal personal income fell at an annual rate of 8.7 percent in the third quarter, the biggest drop since the data were first compiled in 1947.

"Everything went wrong for the consumers," wrote economist Sung Won Sohn, of California State University at Channel Islands. "The surge in oil price hurt spending after adjusting for inflation. The effects of the tax rebate during the second quarter are gone. The ongoing financial collapse and the plunge in consumer confidence did not help.

"Upcoming holiday sales will be one of the worst for decades. Consumers have neither income nor the confidence to go shopping," he said. The only bright spot for consumers has been the price of oil, which has fallen by more than half since the summer, he said.

The decline in growth almost certainly signals that a recession is under way, Sohn added.

The National Bureau of Economic Research, usually considered the official arbiter of whether recessions are taking place, hasn't yet called one. But most economists think a recession has already begun, citing the size of the labor market, which has declined every month this year.

The drop in growth comes at the tail end of an especially dramatic presidential campaign, in which the economic downturn has played a central role. Since the turmoil in the financial markets intensified last month, Republican John McCain has fallen behind Democrat Barack Obama, who has attempted to tie his opponent to what he calls the failed economic policies of President Bush.

Meanwhile, the Labor Department said that new claims for jobless benefits for the week ended Oct. 25 stood at a seasonally adjusted 479,000, unchanged from the previous week and above analysts' estimates of 475,000. Jobless claims above 400,000 are considered a sign of a struggling economy.

Bush administration officials insisted Thursday that while the GDP numbers were bad, the economy is beginning to rebound, thanks to steps taken by the Treasury Department and the Federal Reserve. They have included a series of interest rate cuts, including a half-point cut in the federal funds rate Wednesday, and the $700 billion rescue plan approved by Congress earlier this month.

"We know that while we're making a great deal of progress on the implementation of the rescue and freeing up of credit, it is going to take some time," said Commerce Secretary Carlos Gutierrez.

"We are expecting several difficult months, perhaps a couple of difficult quarters. The important thing is we are making progress, we're getting through it," he said.

The decline in consumer spending is a concern, Gutierrez said. But, he added, "We believe that can be traced directly to the lack of credit in the marketplace and that number should improve as credit flows more freely."

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