The Commerce Department announced that the US economy shrank in the third quarter, in a revelation that should have surprised no one. The loss of 0.3% from the previous quarter signals the recession that everyone knew was coming, and it will likely be followed by at least two more quarters of decline:
A day after the Federal Reserve slashed a key interest rate to battle an economic downturn, the government reported Thursday the economy did shrink in the summer, sending the strongest signal yet that a recession may have already begun.
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.
In fact, it appears to have surprised no one on Wall Street, where traders continue to show mild optimism as liquidity returns to the credit markets. The GDP has less significance now than usual, as markets have already lost trillions in valuation after the collapse of the housing market and the mortgage-backed securities sold by Fannie Mae and Freddie Mac. The loss of valuation has much more to do with the availability of credit, and the efforts of Treasury have lessened worries about that this week.
This morning, the markets appear to be acting rationally, even in the teeth of the GDP report and a slightly higher joblessness report than usual. As of this writing, the Dow Jones is up slightly over 100 points, and almost all of the global markets have kept pace as well. Only Switzerland has fallen off the pace, and that only slightly. Investors appear to be returning to the markets this week as confidence in institutions continues to improve.
But we do face a recession, higher joblessness, and tough economic times for the entire world. How do we successfully endure it and emerge stronger? The Wall Street Journal notes that the next administration will have a lot to say about that, and so far it looks as if they’ll botch it:
Though it often doesn’t seem like it, the world is making progress against financial panic. Capital — public and private — is now flowing into the banking system, reducing the risk of runs or a crash. Though we’re heading into a recession, how deep the downturn becomes will depend on the policy choices our leaders make. …
The larger policy point is that it is a mistake to rely on the Fed and monetary policy to do too much. Mr. Bernanke’s main obligation is price stability. As we’ve seen too often this decade, the Fed gets itself and the economy in trouble when it attempts to use monetary policy to manage growth, or when it lets its monetary decisions be dictated by a lagging indicator like the jobless rate. The Fed needs to look at forward-looking price signals if it wants to avoid another asset bubble down the road.
And if our politicians want to avoid a deep recession, they have fiscal policy — specifically, the economy could now use a big, immediate and permanent cut in marginal tax rates. That would help to spur incentives to invest, as well as increase money velocity. We realize this policy mix isn’t popular among the Democrats who expect to inherit all federal power next week. They’re still proposing to raise taxes substantially amid a recession, and their only proposed stimulus is as much as $300 billion in new spending. As we say, the depth of the recession will depend on our policy choices.
I’ll boil it down to the essentials. A vote for Democratic policy is a vote to extend the recession and make it worse. Harry Reid, Nancy Pelosi, and Barack Obama want to impose higher taxes in the face of a recession as well as put obstacles in global trade. That combination proved disastrous the last time it was used — by Herbert Hoover.