Economy slows, Fed cuts again
The U.S. economy dodged outright contraction during the first three months of the year, growing at a 0.6% annual pace for a second quarter in a row, the government said Wednesday.
The economy’s performance, though positive, was so weak that it helped persuade the Federal Reserve to cut its key interest rate another quarter-point -- to 2% -- and warn that further trouble could be on the way.
“Economic activity remains weak. Household and business spending has been subdued and labor markets have softened. . . . Financial markets remain under considerable stress,” the central bank said in its statement explaining the rate decision.
It was the seventh time in as many months that the Fed had sliced its federal funds rate, the interest that banks charge one another for short-term loans. The action brought the total cutback to 3 1/4 percentage points, and the central bank indicated it might put off further cuts for the time being.
Lowering the funds rate is intended to spur growth by reducing the cost of borrowing, including credit cards and business loans. Recent financial turmoil short-circuited the effect of previous cuts, pushing the Fed to cut further and find new ways to buoy the economy.
As for the government’s latest snapshot of economic conditions, it suggested that much of the growth from January through March was the result of a mistake -- an unintended buildup of unsold goods by businesses. Virtually every other element of the economy, including consumer spending, business investment and once-hot exports, showed new signs of weakness.
“There’s no strength in these numbers,” said John E. Silvia, chief economist with Wachovia Corp., the Charlotte, N.C., banking giant. “When you see business inventories rising and sales falling, that’s bad news. It can’t be sustained.”
The fact that the nation’s gross domestic product, the broadest gauge of its output of goods and services, has continued on a path of meager growth delays, for the time being, any official declaration of recession.
Robert E. Hall, the Stanford economist who heads the committee charged with determining the economy’s peaks and valleys, said that although the panel didn’t defer to the traditional definition of a recession as two consecutive quarters of GDP contraction, its decisions were still influenced by that trend. That makes it unlikely the panel will confirm a recession until there’s been at least one quarter of contraction.
The latest numbers strongly suggest that the economy is headed into what Hall termed in a recent paper a “modern recession.”
These slowdowns differ from the traditional variety: They don’t involve huge layoffs, steep production drops or a slide in the economy’s efficiency. But recovery from “modern” recessions can take extraordinary lengths of time.
People who get caught up in them can be out of work for financially damaging stretches. Prolonged declines in stock and house prices can wreak havoc on family finances by eroding investments and savings and cutting off access to home equity credit.
Hall said the last two recessions -- which occurred early this decade and in the early 1990s -- were distinct from the preceding recessions, in which the economy dived sharply before picking up decisively.
What made most analysts view the latest data as evidence of an economy half-empty, instead of half-full, were signs of weakening in what had been key areas of strength.
Consumers, whose tireless shopping helped prop up the economy last year, switched course in the early months of 2008 and sharply reduced purchases of all kinds of goods.
Spending on big-ticket items such as cars, appliances and furniture, which had been expanding at a 2% annual pace in the fall, contracted at a 6.1% rate. Spending on routine items such as food, which had been growing at a 1.2% rate from October through December, shrank in nearly identical proportion from January through March.
The only thing that kept consumer spending positive was a jump in services, but even there overall spending was up just 1%, sharply lower than the near-4% pace during the same period a year earlier.
Consumer spending accounts for more than 70% of the nation’s GDP.
The nation’s business sector clearly recognized that consumers were pulling their horns in and seemed to want to follow suit. Investment in new buildings, which had been exploding at a 12.4% rate in the fall, sank to just 6.2% during the winter. Investment in equipment and software, which had risen at a 3.1% rate, fell at a 0.7% rate.
But companies apparently didn’t move as fast to shrink their production of goods as consumers moved to stop buying them. The result was that firms inadvertently added to GDP by expanding their stocks of unsold items. Inventory expansion more than accounted for the economy’s overall growth by adding 0.8 of a percentage point to GDP.
“Production remained positive, but demand slipped,” said Richard Berner, chief U.S. economist with Morgan Stanley in New York. “It didn’t collapse, but it definitely slipped.”
Berner and other analysts said another discouraging area was foreign trade, which until recently had been a source of economic strength.
American consumers had been buying fewer imports as the rising value of foreign currencies made them more expensive. And, because of the weak dollar, foreigners had been buying more U.S. exports. The combination of lower imports and higher exports -- so-called net exports -- added about 1 percentage point to GDP for most of last year. But the happy trends reversed last quarter, knocking the contribution down by four-fifths.
Export demand “is still offsetting some of the domestic weakness in the economy, but it is not going to last,” said Steven Wieting, chief U.S. economist with Citigroup Inc. in New York.
Economists said one of the few apparent bright spots in the latest growth report -- a measure indicating that prices have remained stable -- was probably misleading. They said that the measure most likely didn’t capture the most recent run-up in fuel and food prices.
In cutting rates Wednesday, the Federal Reserve suggested that it had done just about enough to cushion the economy and financial markets.
The rate cut vote by the agency’s policymaking Federal Open Market Committee was 8 to 2. As in March, two members, Dallas and Philadelphia Federal Reserve Bank Presidents Richard W. Fisher and Charles I. Plosser, opposed the cuts. Both have said they were concerned that the sharp drop in rates could spark inflation and further weaken the dollar.
In addition to cutting the funds rate, the Fed also cut the so-called discount rate, the interest the central bank charges for direct loans to banks and other financial firms, by a quarter-point, to 2.25%.
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The Fed’s statement
The Federal Reserve’s statement accompanying its interest rate cut Wednesday:
The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2%.
Recent information indicates that economic activity remains weak. Household and business spending has been subdued, and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.
Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.
The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, chairman; Timothy F. Geithner, vice chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting.
In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 2 1/4 %. In taking this action, the board approved the requests submitted by the boards of directors of the Federal Reserve banks of New York, Cleveland, Atlanta and San Francisco.