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More pain: Economy shrinks

Latest GDP report shows that economic activity fell in the third quarter - another warning sign of a recession.

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By Chris Isidore, CNNMoney.com senior writer

If the U.S. enacts a second stimulus plan, what should be its top priority?
  • Extending unemployment benefits
  • Expanding food stamp program
  • Rebate checks to taxpayers
  • Help for small businesses

NEW YORK (CNNMoney.com) -- The nation's economy slammed into reverse in the third quarter and suffered its biggest decline in seven years, according to a government report Thursday.

The gross domestic product, the broadest measure of economic activity, fell at an annual rate of 0.3%. That compared with a 2.8% growth rate in the second quarter, when growth was boosted by economic stimulus checks and strong exports.

The third quarter decline wasn't quite as bad as experts had forecast. Economists surveyed by Briefing.com had estimated GDP would fall 0.5%.

Still, the latest report is yet another warning sign of recession and marked only the fifth quarter in more than 17 years in which GDP did not increase. The report, which covers the three months that ended Sept. 30, did not reflect the full impact of the recent crisis in financial and credit markets.

Commerce Secretary Carlos Gutierrez told CNNMoney.com Thursday that the nation is likely looking at a couple of difficult quarters ahead, although he wouldn't comment on whether the economy has already fallen into a recession.

"I won't get into the labeling debate," he said, while conceding that a negative GDP reading is a worry.

"It is what it is," he said. "It's not what we like to see."

The White House issued a statement pointing to numerous factors that contributed to the weakness, including record high energy prices, housing and credit concerns, two major hurricanes, and a prolonged Boeing strike.

"While we continue to face serious challenges, the United States remains the best place to do business, and we're positioned to bounce back," said White House Press Secretary Dana Perino.

There was a hearing on Capitol Hill Thursday after the report on whether there should be a second economic stimulus package. Rep. Carolyn Maloney, D-N.Y., spoke in favor of new help to consumers, the unemployed and local governments, while Rep. Kevin Brady, R-Texas, criticized the idea, saying the economic stimulus package passed earlier this year had not done the job.

Gutierrez said the administration stands ready to discuss a possible stimulus plan with Congressional leaders but it wants to make sure that any help be short-term in nature. He said the administration would like to give the $700 billion Wall Street bailout passed earlier this month a chance to work.

"That is the single biggest stimulus we can do for the economy," he said. "We are already beginning to see indicators that the credit market is beginning to thaw a bit."

As bad as the GDP number was, deeper economic problems loom. Strong exports, spurred by a weak dollar, helped to mitigate the third-quarter downturn. Even Gutierrez conceded the recent rise in the dollar's value and the slowdown of foreign economies will likely dampen gains from exports going forward, although he said he's hopeful that exports can continue to stay strong.

"I would expect that looking down the road, that trade will be a significant part of our future unless we put in place policies that restrict trade," he said.

The report also showed that gross domestic purchases fell 1.3% - the worst reading in 17 years and the third quarter in the last four that has been negative. Spending on durable goods, such as automobiles, showed the biggest decline in 24 years. Meanwhile, spending on nondurables, such as gasoline and food, fell by the most in 58 years when adjusted for inflation as consumers, businesses and governments cut back in the face of higher prices.

Spending by consumers dropped by the largest amount since early 1980. The decline dragged the overall GDP down by 2.25 percentage points - worse than what occurred in the last three recessions in 1982, 1991 and 2001.

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

At Thursday's hearing, New York University economics professor Nouriel Roubini said the GDP report is the clearest sign yet that the country is in a recession and that there needs to be quick congressional action on a new stimulus plan.

"If it walks and quacks like a recession duck, it is a recession duck," he said. He added that the sharp fall in consumer spending is of particular concern.

"Everybody out there feels it," he said. "It's obviously a recession. The only debate at this point is how severe, how protracted."

Roubini called for a stimulus plan that would increase government spending rather than give a new round of tax rebates and business tax incentives like the previous stimulus passed earlier this year.

"If the private sector does not want to spend, the government can spend. If we don't do anything we'll have most severe recession we've had in decades," he said.

But several Republican members of the committee, as well as Ohio University economics professor Richard Vedder, argued that government spending plans have a poor record at spurring the economy and that it's more important to keep deficits under control.

Vedder said that spending as much as $400 billion on a second stimulus package on top of the more than $1 trillion already committed by the Federal Reserve and Treasury Department to address the credit crunch would not be a good idea.

"I think it's a dangerous and somewhat fiscally irresponsible thing to do. In the long run it will inspire a decline in confidence," Vedder said.

Both presidential candidates said the report's weakness was a further argument for their economic proposals and against those of their opponent.

"The decline in our GDP didn't happen by accident - it is a direct result of the Bush administration's trickle-down, Wall Street-first, Main Street-last policies that John McCain has embraced," said a statement from Democratic candidate Barack Obama.

The McCain campaign said Obama's proposals represented change the economy could not afford.

"Obama's ideologically-driven plans to redistribute income will impose higher taxes on families, small businesses, and investors; expensive, rigid, job-killing health mandates on employers," said the statement from McCain economic adviser Douglas Holtz-Eakin. To top of page

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