U.S. economy shrank in the third quarter

updated 3:20 p.m. ET Oct. 30, 2008

WASHINGTON - 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.

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.

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