Image: An escalator in a shopping mall
David Mcnew  /  Getty Images file
Shoppers ride an escalator in a shopping mall in Pasadena, Calif. The economy jolted into reverse during the third quarter as consumers cut back on their spending by the biggest amount in 28 years, a signal the country has hurtled into a recession.
updated 10/30/2008 3:20:49 PM ET 2008-10-30T19:20:49

The government reported Thursday the economy shrank in the summer, the strongest signal yet that a recession may have already begun, a day after the Federal Reserve slashed a key interest rate to battle an economic downturn.

The Commerce Department reported that the gross domestic product, the broadest measure of economic health, fell at an annual rate of 0.3 percent in the July-September period, a significant slowdown after growth of 2.8 percent in the prior quarter.

The spring activity had been boosted by the $168 billion economic stimulus program, but the economy ran into a wall in the summer as the mass mailings of stimulus checks ended and consumer confidence was shaken by the upheavals on global markets. Consumer spending, which accounts for two-thirds of the economy, dropped by the largest amount in 28 years in the third quarter.

The classic definition of a recession is two consecutive quarters of negative GDP. Many analysts believe the GDP will decline in the current October-December period by an even larger amount and they are forecasting a negative GDP figure in the first three months of next year.

The National Bureau of Economic Research, which is the official arbiter of recessions in this country, has not said when it will make its determination of whether the country has entered a recession.

Meanwhile, the Labor Department reported Thursday that applications for unemployment benefits remained at an elevated level last week, another sign of the economy’s struggles. The number of laid-off workers filing new claims totaled 479,000, the same as the previous week, disappointing analysts who had expected a small drop.

On Wednesday, the Fed cut the federal funds rate — the interest banks charge each other on overnight loans — by half a percentage point, and the government finally began distributing funds from the billions in the financial rescue package.

Those efforts were part of a concerted drive by officials, just days before a national election, to demonstrate they are moving as quickly as possible to deal with the most serious financial crisis to hit the country since the 1930s.

“Policymakers have their foot to the accelerator and they are using every effort at their disposal to stop the slide in the economy and financial markets,” said Mark Zandi, chief economist with Moody’s Economy.com. “And it’s not a moment too soon given the serious damage that has already been done.”

While Wall Street posted its second biggest point gain in history Tuesday in anticipation of the Fed rate cut, the bleak economic reality appeared to ensure that the euphoria was short-lived. The Dow Jones industrial average rallied Thursday morning after closing down 74 points on Wednesday, a drop analysts said partly reflected growing worries about whether the government’s actions will be sufficient to avert a deep and prolonged recession.

The Fed, as investors had hoped, announced the half-point cut in the federal funds rate, driving it down to 1 percent, a low last seen in 2003-2004. That rate has not been lower since 1958 when Dwight Eisenhower was president.

Major Market Indices

Reducing the rate as low as zero cannot be ruled out, some analysts said, but they cautioned that reducing rates that far carried some risks, including that if the credit crisis suddenly worsened, the Fed would have used up its ammunition.

Analysts also noted that just lowering rates cannot serve as a panacea to overcome a credit crisis. While the goal is to encourage banks to begin lending again, financial institutions are skittish about extending new loans given the huge losses they have racked up in bad mortgages.

Meanwhile, the administration announced that the spigot had been opened on the $700 billion fund created by Congress Oct. 3 to rescue the U.S. financial system. Treasury issued a report showing checks had been disbursed for $125 billion in payments to nine major banks, including Bank of America, Citigroup, JPMorgan Chase, Goldman Sachs and Morgan Stanley. The goal is to bolster their balance sheets so they will resume more normal lending.

And the administration was nearing an agreement on a plan to help around 3 million homeowners avoid foreclosure, according to sources who had been briefed on the matter. The program would be the most aggressive effort yet to limit damages from the severe housing slump.

Besides cutting interest rates, the Fed announced it was extending credit lines worth $30 billion each to the central banks of Brazil, Mexico, South Korea and Singapore in an effort to bolster financial markets in those countries and relieve investors’ anxieties.

It brought to 14 the number of central banks that the Fed has entered into so-called swap arrangements for currency as a way to pump more liquidity into global credit markets, part of an effort that the Bank of England estimated has resulted in $5 trillion in support being put forward by governments worldwide.

The International Monetary Fund unveiled a new streamlined lending process to get support to countries caught up in the credit crisis, another effort by the 185-member institution to show it was prepared to perform its job as lender of last resort to countries facing difficulties. The IMF already has moved to help Iceland, Ukraine and Hungary with other nations quickly lining up for aid.

The Fed’s half-point interest rate cut marked the second rate reduction this month. The Fed slashed the rate by a half-point on Oct. 8 in a coordinated action with other foreign central banks. Economists predict foreign central banks will follow suit with another round of rate cuts over the next week.

In a brief statement explaining Wednesday’s action, the Fed said that “downside risks to growth remain” holding out the promise of further rate cuts if needed. The rate-cut decision was unanimous.

Many analysts said they believe the Fed will not stop at 1 percent if officials see the need to cut rates further. Some are forecasting another half-point move at the Fed’s last meeting of the year on Dec. 16.

But other economists said with rates already so low, the Fed may decide to hold at 1 percent, leaving some room for a further reduction next year should the country’s economic troubles intensify.

The Fed’s action was quickly followed by a reduction by commercial banks in their prime lending rate, the benchmark for millions of consumer and business loans, which was cut from 4.5 percent down to 4 percent, its lowest level in four years.

The central bank also announced that it was lowering its discount rate, the interest it charges to make direct loans to banks, by a half-point to 1.25 percent. This rate has become increasingly important as the central bank has dramatically increased direct loans to banks in an effort to break the grip of the credit crisis.

© 2013 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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