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Economy slows, Fed cuts again

A miscalculation on inventories keeps the trend barely positive. Central bank signals it may stay on sidelines.

May 01, 2008|Peter G. Gosselin | Times Staff Writer

WASHINGTON — 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.

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