Economy shrinks as spending ebbs

The US economy contracted in the third quarter as the sharpest drop in consumer spending in nearly 30 years erased any remaining doubts that the nation is in a recession, analysts said.

The Commerce Department reported yesterday that the economy shrank at a modest 0.3 percent annual rate in the quarter ended Sept. 30, a better than expected performance that helped send stocks soaring yesterday. The Dow Jones industrial average rose 190 points to close at 9,180.69.

But analysts said strong exports and government spending, particularly on defense, masked increasing troubles in the broader economy. Consumer spending, the biggest and most important component of the economy, plunged at an annual rate of more than 3 percent, the worst decline since 1980. Businesses cut spending on equipment and software for the third consecutive quarter, while residential construction plunged nearly 20 percent.

There are indications of more bad news to come. Exports, which have provided key support to the economy, are expected to decline as a global downturn hurts foreign demand, while the trillions of dollars of value lost in the brutal stock sell-off of the past month will likely result in another sharp decline in consumer spending. The result: accelerating job losses and unemployment that could hit 8 percent, a level not seen since the early 1980s, economists said.

Unemployment was 6.1 percent in September.

"We are on a downward trend," said Nigel Gault, chief US economist at IHS Global Insight in Lexington. "Everyone can see the signs and realize that the next couple quarters are going to be clear declines for the economy."

The signs are gloomy in Massachusetts, too. Yesterday, Associated Industries of Massachusetts reported that business confidence in the state fell to its lowest level since the recession of the early 1990s.

Consumer confidence in the state also remained at levels not seen since the early 1990s, Mass Insight, a Boston research firm, reported yesterday.

Confidence is considered an important indicator because consumers are less likely to spend and businesses less likely to invest, expand, and hire when they are pessimistic about economic conditions.

"This is so much driven by psychology," said Brian Gilmore, the AIM spokesman. "The continued decline in confidence is most likely the result of the global financial meltdown. We've just been bombarded by bad news."

The National Bureau of Economic Research, the Cambridge nonprofit that dates US business cycles, has yet to officially declare a recession, a painstaking process that typically concludes several months after a recession begins. Most economists, however, say the United States is already in recession.

The common definition of a recession is two quarters of negative growth in gross domestic product, the broadest measure of economic activity. The third quarter of 2008 would be the first such period. But many economists, including those at the research bureau, say GDP is only one component to be considered in determining the beginning of a recession.

Some analysts say the economy has been in recession since the end of last year, despite modest growth in GDP. A wide array of economic activities, including employment, retail sales, and industrial production, have declined steadily this year. US employers, for example, have cut jobs in each of the past nine months, totaling more than 750,000.

Many economists forecast the US economy will continue to shrink at least through the spring, before beginning to rebound in the second half of next year. Last week, the University of Massachusetts said the state is already in or will be in a recession within the next six months.

In a speech to the Greater Boston Chamber of Commerce, former Treasury secretary and Harvard University president Lawrence Summers said yesterday the economy could begin to recover near the end of next year if the government intervenes aggressively. Until recently, he said, the federal government has acted too cautiously in addressing the credit crisis, threatening to bring down the financial system and spur a deep global recession.

He suggested more stimulus is needed beyond the $700 billion federal rescue package, a portion of which is being used by the Bush administration to buy ownership stakes in banks to inject capital and get them lending again. In a crisis driven by fear and lack of trust, making sure banks have adequate capital to resume lending is not enough to restore confidence, he said. Government needs to make sure they have more than enough, Summers said.

"Markets always overreact, so policy has to overreact if we are to restore the economy," said Summers, a Harvard economics professor and an adviser to Senator Barack Obama, the Democratic presidential nominee.

At this point, economists said, such stimulus can't stop a recession, only make it less severe. The Federal Reserve this week cut its key interest rate to a historically low 1 percent, and is expected to drop the rate again before the end of the year. Congress, meanwhile, is expected to pass a spending package of at least $150 billion after the election to provide a further boost.

In addition, the plunge in oil prices is putting more money in consumers' pockets. Crude prices fell $1.54 to close at $65.96. That's down from the July peak of more than $145 a barrel.

Robert Gavin can be reached at rgavin@globe.com.