Third Quarter GDP Suggests U.S. Has Entered Into Recession

By Jason Simpkins
Associate Editor

The U.S. economy shrank at an annualized rate of 0.3% in the third quarter – the biggest decline in seven years – after businesses cut back on investments and consumer spending experienced its sharpest pullback since 1980. And though the contraction was smaller than economists expected, they are still predicting a drawn-out downturn that could be one of worst U.S. recessions since the Great Depression.

After growing 2.8% in the second quarter of the year, U.S. gross domestic product (GDP) contracted 0.3% during the three months ended Sept. 30. Although investments by businesses dropped 1%, a consumer-spending cutback was the clear culprit: The 3.1% decline was the first such retreat in 17 years and was the biggest pullback in 28. And since consumer spending is the biggest component of GDP – accounting for as much as 70% of economic activity – there was no escape.

"We look at consumers being at 70% of growth and now they're the engine of decline," Jeoff Hall, chief U.S. economist for Thomson Reuters-IFR Markets, told CNNMoney.

Third-quarter spending fell 3.2% and shaved 2.25 percentage points off of GDP growth. Purchases of durable goods plummeted 14.1% in the quarter, and spending on non-durable goods dropped 6.4%. Services spending rose 0.6%.

Mounting job losses and shrinking incomes are expected to lead the country even deeper into recession in the New Year. The GDP report showed that disposable personal income dropped at a rate of 8.7% in the third quarter – the steepest decline since that component was first tracked in 1947.

At 479,000, the number of U.S. workers filing new claims for unemployment benefits stagnated last week, but remained above the average for the entire 2001 recession. The four-week average of new claims, a less volatile measure, fell for a second straight week, but a level of more than 400,000 is consistent with the country’s last two recessions. 

“There can be no question that the labor market is deteriorating; the only issue is the speed of the decline and the eventual peak in unemployment," Ian Shepherdson, economist at High Frequency Economics, wrote in a note to clients. 

Shepherdson estimates that the national unemployment rate, which currently stands at 6.1%, could reach 8.5% next year.

"This is the first of a run of negative GDP numbers; the economy is in recession," Shepherdson said.

With home prices caught in a downward spiral and foreclosure rates still near record highs, the deteriorating job market will put even more pressure on the American consumer – even if the government's $700 billion financial bailout package and the U.S. Federal Reserve’s rate cuts restore some functionality to the battered credit markets.

"Given the scope of job losses seen thus far and still to come, sagging wage gains, restrictive credit conditions, and the ongoing housing market correction, consumer spending is on course for an even larger decline," Richard Moody, chief economist at Mission Residential, told
USA Today. Moody says the negative 0.3% GDP estimate will be subject to downward revisions in the months to come, meaning the economy won't recover until the second half of 2009.

“The crisis really kicked up in late September,” Ethan Harris, co-head of U.S. economic research at Barclays Capital Inc. (ADR: BCS) in New York, said in a Bloomberg Television interview. “We're going to be looking at a very unfriendly GDP number in the fourth quarter, with a drop of 2% to 4%.”

Swimming Against the Tide of Recession

The U.S. Federal Reserve cut its benchmark Federal Funds rate to 1% Wednesday, hoping the move would further unfreeze lending and also lessen the financial fallout wrought by the credit crisis. It marked the ninth time the central bank has lowered rates since September 2007.

The Fed has also loaned hundreds of billions of dollars to banks through a new lending program and earlier this week began loaning money directly to major businesses by purchasing commercial paper.

The People’s Bank of China also cut its key interest rate Wednesday, sending that lending benchmark from 6.93% down to 6.66%.  That was the third time China cut rates in the past two months.

China’s economy registered a solid GDP expansion of 9% in the third quarter – a noticeable step down from the torrid 11.9% pace set in 2007.

Japanese Prime Minister Taro Aso yesterday (Thursday) unveiled a $50 billion economic stimulus package, the nation’s second in as many months.

Roughly $20 billion will go to handouts, distributed evenly, with the average payout of $608 per family of four, The Financial Times reported. Tax breaks on mortgages will also be increased and highway tolls reduced. The package also includes more than $200 billion in government loan guarantees for small and medium-sized businesses.

The Bank of Japan (BOJ) is expected to reduce interest rates today (Friday), as well. And the European Central Bank (ECB) and Bank of England are expected to follow suit next week.

“A harsh storm seen only once in 100 years is raging,” Aso, the Japanese prime minister, said at a news conference detailing the moves.

The International Monetary Fund (IMF) predicts the world economy will expand just 3% next year – the slowest pace since 2002, and an average that the world body says borders on a global recession. Other forecasters, such as economists working for Morgan Stanley (MS), say that a worldwide recession is already under way.

News and Related Story Notes:

• CNNMoney:
  More pain: Economy shrinks

• USA Today:
  Economy flashes recession signal; GDP down at 0.3% rate

• Money Morning:
  Federal Reserve, Bank of China Cut Interest Rates as Financial Crisis Deepens

• Financial Times:
  Japan unveils economic stimulus package