NYT : Low Spending Is Taking Toll on Economy

Low Spending Is Taking Toll on Economy

By PETER S. GOODMAN | May 1, 2008

For months, beleaguered American consumers have defied expert forecasts that they would soon succumb to the pressures of falling home prices, fewer jobs and shrinking paychecks. Now, they appear to have given in.

On Wednesday, the Commerce Department reported that the economy continued to stagnate during the first three months of the year, with a sharp pullback in consumer spending the primary factor at play.

Pressures on households in which cash is tight appeared to weigh significantly in the calculations of the Federal Reserve as it rolled back interest rates Wednesday for the seventh time since September — this time by one-fourth of a percentage point — in a bid to prevent a further falloff in the economy.

The Fed made clear, though, that investors and borrowers should not expect another drop in interest rates anytime soon. In the statement accompanying their action, policy makers said they believed that with the short-term rate at 2 percent, they had already unleashed enough economic stimulus to “help promote moderate growth.”

With the overall economy growing at a mere 0.6 percent annual rate for the second quarter in a row, consumer spending advanced by only 1 percent, the government estimated. That was down sharply from the 2.9 percent gain for all of 2007 and the 3.1 percent gain for 2006. It was the weakest showing since 2001, the last time the economy was ensnared in a recession.

Even more ominously, Americans cut back on a wide variety of discretionary purchases, conserving their cash for necessary spending.

In the dip, economists saw evidence that the basic laws of arithmetic are now impinging on millions of households.

As real estate prices plunge, so does the ability of homeowners to borrow against the value of their homes, crimping a major artery of spending. As banks grow tighter with their dollars in a period of uncertainty, families are running up against credit limits, forcing many to live within their incomes. And as companies lay off employees and cut working hours, paychecks are effectively shrinking.

“This is not a fluke or a technical quirk,” said John E. Silvia, chief economist at Wachovia in Charlotte, N.C. “It’s fundamental. Real disposable income has been squeezed.”

Consumer spending fell for a broad range of goods and services, including cars, auto parts, furniture, food and recreation, reflecting a growing inclination toward thrift. Areas in which spending rose were predominantly those not considered optional purchases, including health care, housing and utilities.

The fact that the economy expanded at all, even by a tiny margin, sowed hopes that a recession might yet be averted. But most economists found in the details of the preliminary report signs of broadening economic distress at home even as businesses expanded production to meet growing demand from abroad.

A panel of economists at the National Bureau of Economic Research, a private research organization, ultimately decides whether a particular period of weakness qualifies as a recession, which it defines as a “significant decline in economic activity spread across the economy, lasting more than a few months.”

Jared Bernstein, senior economist at the labor-oriented Economic Policy Institute in Washington, said, “The argument that we’re not in a recession certainly gets a little bit more of a boost from this report.”

But he and many other specialists still assume the economy will slide into negative territory. Moreover, the recession-or-not question is now almost entirely academic, Mr. Bernstein contended, given the steady erosion of American spending power and soaring costs for food and gasoline.

On Wednesday, the Labor Department reported that wages and benefits, adjusted for inflation, were down 0.6 percent in the January-March period, compared with a year earlier.

“A very significant slowdown in the economy has caused a lot of pain,” Mr. Bernstein said. “That’s a done deal.”

The Commerce Department reported that growth was hampered in the first three months of the year by a continued decline in home construction, which fell for the ninth straight quarter, and by a pullback in investments for business equipment and buildings.

The only factors preventing the economy from sliding backward were the growth of American exports — aided by a weakening dollar — and a swing in business inventories from shrinking to swelling. Putting exports and inventories aside, the final sales of goods and services produced domestically dipped at a 0.4 percent annual rate in inflation-adjusted terms, the first such decline since the end of 1991.

“You’re seeing a sharp slowdown in domestic demand,” said Michael T. Darda, chief economist at MKM Partners in Greenwich, Conn. “This is stall-speed growth.”

Economists suggested that larger stocks of unsold goods might portend trouble in the months ahead. If business does not swiftly improve, allowing factories to sell the products they have piled up, firms are likely to lay off workers at a more aggressive clip.

Even if business picks up and orders materialize, averting broader layoffs, factories will probably not need to produce as many new things in coming months, prompting some to trim working hours and purchases of materials.

“A big inventory contribution in one quarter means a payback in another quarter,” said Zach Pandl, United States economist at Lehman Brothers. “Firms are likely to pull back.”

The biggest questions ahead center on the duration and severity of the downturn. Attention now turns to the job market and the tax rebate checks being sent out to roughly 130 million American taxpayers to encourage spending.

On Friday, the Labor Department is to release its monthly snapshot of the jobs picture, which has become a primary factor gnawing at the economy. For four months in a row, the private sector has shed jobs, with 80,000 nonfarm jobs lost in March alone, according to the Labor Department.

If, as widely expected, the jobs report shows another monthly decline, markets are likely to absorb it as a sign of an economy that has effectively slipped into a recession despite the modestly reassuring positive figures from the Commerce Department.

Most economists agree that the tax rebate checks will finance a flurry of spending that should stimulate economic growth. But whether it will be a quick binge lasting only a few months, or whether spending will crystallize a sense of confidence, prompting companies to expand and hire, is a matter of much contention.

Even with the rebate checks, consumer spending should grow by only 1.7 percent this year and roughly the same next year, predicted Alan D. Levenson, chief economist at T. Rowe Price Associates in Baltimore. With spending that weak, the economy would probably continue to shed 75,000 to 80,000 jobs a month, even after stronger growth resumes, he said.

The government has offered the rebate checks to buy time while it waits for the Fed’s lowered interest rates to wash through the economy, nurturing fresh investment and hiring. But many economists are skeptical that such timing can be pulled off. Many forecasts show a dip in economic activity from April through June, then a bump up from the rebate checks before the economy slows again at the end of this year.

“It doesn’t get us across the chasm,” said Robert Barbera, chief economist at the research and trading firm ITG, speaking of the rebate checks. “It will make things look better than they are for a few months, but it doesn’t change the fundamentals. The underlying circumstances are unambiguously recessionary.”