Consumers Cutback, GDP Contracts in Third Quarter, a Recession Call?

The U.S. economy shrank during the third quarter as consumers cut back on their spending by the largest amount in 28 years, underscored the terrible toll of the housing, credit and financial crises as well as sent the strongest signal the country has plunged into recession.

Real Gross Domestic Product (GDP) shrank at a 0.3 percent annual rate in the third quarter, the Commerce Department reported Thursday. The decline was the largest since the end of the last recession in late 2001.

The third-quarter figure isn’t the first decline in economic output since the credit crisis started last year. Revisions to 2007 gross domestic product, released in July, showed that the economy contracted at a 0.2 percent annual rate in last year’s fourth quarter.


Consumers Cutback

The economic deterioration reflected a sharp cutback by consumers, whose spending accounts for the largest portion of national economic activity. In the third quarter consumers ratcheted back their spending at a 3.1 percent pace, the first decline in 17 years. The cutback also marked the sharpest quarterly drop since the second quarter of 1980, or 28 years ago, when the country was fighting runaway inflation in the grip of recession.

Underscoring the strain faced by consumers, the report showed that Americans' disposable income fell at an annual rate of 8.7 percent in the third quarter, the largest quarterly drop on records dating back to 1947.

In addition to consumers, businesses cut back sharply in the third quarter. They cut spending on equipment and software at a 5.5 percent pace. Home builders slashed spending at a 19.1 percent pace, marking the 11th straight quarterly cut back, and fresh evidence of the depth of the housing slump.


A Recession Call?

Following the release of the third quarter GDP contraction, most economists are forecasting at least two more negative quarters. The expected contraction until next year would more than meet a classic definition of recession, which is two straight quarters of shrinking GDP that didn't happen in the last recession, in 2001.

Series adverse shocks would be reasonable to send an economy into recession. A collapse of the housing market, and dried up lending have produced the worst financial crisis to hit the country in more than 70 years. An oil shock as big as those of the 1970s has worsened the already battered economy.

The National Bureau of Economic Research (NBER), the panel of experts that determines when U.S. recessions begin and end, uses a broader definition to determine recessions than two quarters of contracting GDP. The committee follows five key indicators to define a recession, of which the two most important are GDP and employment. The finding is usually made well after the fact.

In 2001, the committee weighed in at the end of November to pinpoint the recession starting point to March, when employment started declining. That year, the first negative GDP number came at the end of October showing a 0.4 percent annualized GDP decline in the third quarter of 2001. The figure was since revised to show a 1.4 percent decline for the quarter, and government figures later showed a GDP decline in the first quarter of that year as well.

Going into the fourth quarter there were two major problems weighing on the broader economy: tight credit, the continued deterioration in the housing market, and rising unemployment. The clearer indications of recession have already brought down energy prices, and there are tentative signs of improvement in the credit markets.

However, the housing market is a problem that isn’t going away. Tight credit conditions, mounting job losses and a weaker economy are likely to continue putting pressure on home prices.

Unemployment is expected to rise from its current level of 6.1 percent. Disappearing jobs, falling incomes, battered nest eggs and retirement accounts, and falling home prices are likely to make consumers retrench even more.

The 1981-82 recession lasted 16 month in which the unemployment rate hit 10.8%. The 1990-91 recession ran eight months but was followed by weak credit conditions for years as banks sought to rebuild. And the 2001 recession also was mild in length but employment declines stretched for almost two years after the eight months recession ended.


Wall Street Reaction

U.S. stocks rallied Thursday, pushing the Dow Jones Industrial Average back above the 9,000 level, after the government said the economy shrank less than forecast in the third quarter. The Dow Jones Industrial Average gained 189.73 points, or 2.1 percent, to 9,180.69. The S&P 500 climbed 24 points, or 2.6 percent, to 954.09, while the Nasdaq Composite rose 41.31 points, or 2.5 percent, to 1,698.52.

On the following day the stock market ended higher, but it closed out a dire October with a worst month record in 21 years. The Dow Jones industrials ended the month down 14.1 percent, while the broader Standard & Poor's 500 index lost 16.9 percent during October as the stock market fell victim to investors' anguish over frozen credit markets and what looked like an inevitable recession.