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Robust 7.2% growth gives economy a jolt

Published Sep. 2, 2005

The U.S. economy, firing on all cylinders, expanded this summer at the fastest pace in nearly two decades, even as it was losing jobs.

Consumer spending soared, foreigners bought American-made goods at a surprising clip and companies increased their investments in equipment and technology.

The nation's gross domestic product _ the sum of all the goods and services produced in the United States _ grew at an annual rate of 7.2 percent in the three months that ended in September, said the Commerce Department, which adjusts its numbers to take into account inflation and normal seasonal fluctuations. It was the highest growth rate since the first quarter of 1984. In two other quarters since 2001, the economy expanded at least 4 percent in a single quarter, only to fall back into a slump that made companies reluctant to hire workers and helped create the worst job loss in 20 years.

Fueled by personal income tax cuts that became effective in July and a record surge in home-mortgage refinancing that gave homeowners more cash to spend, consumer purchases rose at a very strong 6.6 percent annual rate in the third quarter, by far the strongest factor in the gain in the nation's economic output, or gross domestic product. Businesses also got new tax incentives to invest.

However, many forecasters expect the effects of the personal tax cuts and the refinancings to wane as time passes. Several predict that growth will drop back to about a 4 percent annual rate for the remainder of this year and in 2004, a pace some economists fear might not be fast enough to produce many new jobs.

"Both the tax cuts and the refinancings were one-time events," said Lee Price, research director of the Economic Policy Institute. He said he is concerned the lack of new jobs and weak wage and salary income could restrain future economic growth.

"Maybe this strong quarter will kick in and employers will decide to begin hiring," Price said. But that's not assured because companies have been able to boost production without having their current employees work longer hours, much less add more workers, he said. "Output per hour is going to be up at more than a 10 percent annual rate for the quarter," he said, and unless those gains slow significantly, a 4 percent economic growth rate won't add jobs.

Gregory Mankiw, chairman of the Council of Economic Advisers, said that even though the number of payroll jobs has declined this year, the administration's tax cuts have kept employment higher than it otherwise would have been.

"About 1.5-million more people are working than would have been had the president never changed the tax code," Mankiw said. "It's hard to sort of determine the exact cause and effect of any particular economic change, but certainly there's lots of reasons to believe that what we saw in (the third) quarter is attributable to the president's jobs and growth package. The president's package put money in the hands of consumers, and you saw very strong consumer spending. The jobs and growth package was aimed at lowering the cost of capital and you saw very rapid investment spending.

"It would be unrealistic to assume that 7.2 percent growth would continue, but we certainly expect growth to continue at a robust pace," Mankiw said. "There's a lot of stimulus in the pipeline and lots of sort of good signs in the data."

However, Rep. Fortney "Pete" Stark of California, senior Democrat on the Joint Economic Committee, emphasized the lack of new jobs.

"Economic growth without jobs is no help for the unemployed," Stark said. "There were 146,000 fewer jobs in September than there were in June. The unemployment rate was 6.1 percent in the third quarter, nearly as high as the second quarter's 6.2 percent," with the number of long-term jobless people rising and the number of workers exhausting their unemployment insurance benefits climbing.

In other encouraging economic news from the Labor Department, new claims for unemployment benefits last week dropped by 5,000 to 386,000, a sign that layoffs are slowing. U.S. workers' wages and benefits rose 1 percent in the third quarter, compared with 0.9 percent from April through June.

Thursday's report is likely to allay some fears at the Federal Reserve that the three-year period of weak growth has left the economy vulnerable to a sustained period of falling prices, known as deflation. Prices for consumer goods rose 2.4 percent during the quarter, up from an increase of 0.8 percent during the second quarter of 2003.

The Fed has kept its benchmark short-term interest rate at 1 percent, its lowest level since 1958, partly to ward off the kind of deflation that has afflicted Japan recently. On Tuesday, the Fed said it planned to keep interest rates low for a "considerable period."

"There are a thousand problems that remain," said Robert Barbera, chief economist of ITG/Hoenig, an investment firm. "But the No. 1 problem _ would we end up like Japan because no amount of stimulus could get us out of this? _ has been resolved."

Economist Sung Won Sohn of Wells Fargo Banks said a key reason for the surge in growth was that for the first time since the end of the 2001 recession "consumers and businesses are joining forces."

Until the third quarter, the recovery had been restrained primarily due to very weak business investment in new structures, equipment and software because of overinvestment during the boom of the late 1990s. Investment in business structures was weak in the third quarter, but spending on equipment and software increased at a 15.4 percent annual rate, after an 8.3 percent rate in the second quarter.

Spending by consumers and businesses was so strong in the third quarter that meeting their demand forced companies to reduce their stocks of unsold goods substantially. Had production been boosted enough to keep inventories level, the gain in the nation's inflation-adjusted gross domestic product would have been 7.8 percent.

Sohn also said he expects that growth in the fourth quarter and next year won't be as robust.

"The positive effect of the tax cut will diminish," Sohn said. "Interest rates, including mortgage rates, have been trending up. Cars and housing could become a bit of a head wind" rather than a big plus.

_ Information from the New York Times and the Associated Press was used in this report.

What's fueling the economy?

Gross Domestic Product is the measurement of the value of goods and services produced by a nation within its boundaries.

Here are the four main pieces of the 7.2 percent rate of growth in the GDP:

(other minor components affect final total):

Personal Consumption 4.66 percentage points

This covers purchases by individuals of just about anything, from cars and washing machines to food.

Gross Private Domestic Investment 1.37 percentage points

This includes homes, factories and office buildings, as well as major business purchases of items such as computers and software.

Net Exports of Goods and Services 0.84 percentage points

Government Expenditures 0.27 percentage points